Dual-Class Shares: The Good, The Bad, and The Ugly

Top Three Risk Factors

The report reveals the results of a survey of CFA members in Asia Pacific, which CFA Institute carried out in March this year. The survey respondents identified three key risks in the event DCS became widely available: insufficient or absent minority investor protection (53%); skewed proportionality between ownership and control (52%); and a potential race to the bottom in terms of corporate governance standards (28%). The survey also found that regardless of whether respondents were in favor of or opposed to DCS, nearly all respondents (97%) thought that additional safeguards were necessary. Furthermore, a majority (60%) of respondents had no experience investing in firms with DCS structures, which suggests that all market participants would benefit from further education about DCS and the associated risks.

The lack of widespread experience with DCS is of particular importance for investors in Asia as the introduction of DCS to Hong Kong and Singapore in the first half of this year could lead to a race to the bottom as other exchanges in the region contemplate a similar move.

“Time is not on our side,” concluded Mary Leung, Head of Advocacy, Asia Pacific, CFA institute. “Regulators in the region should educate the public immediately on the pros and cons of investing in DCS companies to raise awareness of the risks and keep the markets healthy.”

Key recommendations

“Everyday investors in Asian jurisdictions such as Hong Kong, where class actions and derivative actions are unavailable, are particularly susceptible to the entrenchment risks of super shareholders created by dual class share structures, and it is difficult for them to protect themselves against such risks without an appropriate regulatory framework,” noted Ms. Leung. CFA Institute believes that, in addition to investor education, the single most important safeguard for investors is a mandatory time-based sunset on DCS structures of not more than five years.

In addition, regulatory frameworks in many Asian markets currently make it either impractical or too expensive for small investors to pursue remedies for losses on their own. Accordingly, CFA Institute also urges governments and regulators to establish a mechanism for small investors to seek recourse when faced with rogue companies and management acting in their own self-interest.

Challenging the DCS Myth

While Asia is a relative latecomer to DCS structures, the report gives a historical overview of how such structures have impacted investors in the United States. Historically there has been some evidence that DCS offerings have been relatively more prolific in times of market euphoria and high levels of systemic liquidity. At such times investors have been less discerning and more accepting of weaker corporate governance structures, which have tended to underperform when market conditions reverse and become less favorable.

The report contains a literature review of the stock market performance of DCS companies, including their performance over time, a growing focus in the last two years. While a great deal of attention has been given to Alphabet (parent of Google) and Facebook, both of which have been highly successful, there are many other successful global technology companies, including household names such as Apple, Microsoft, Amazon, and Netflix, which do not use DCS structures and offer only one class of shares.

On the other hand, there have been plenty of instances when technology companies with a DCS structure have not delivered for investors, including, for example, Snap. Other case studies in the report illustrate common risks associated with DCS structures, such as entrenchment and reduced levels of accountability, which often lead to depressed share prices, thus highlighting the importance of sunset provisions.

In addition to a review of the debate surrounding DCS, the report also examines the implications for policymakers. It presents an array of stakeholders’ views, including those of asset owners, exchange operators, regulators, accountants, and institutional investors. The report is available on the CFA Institute website and CFA Asia-Pacific Research Exchange. Hard copies are also available for collection from the CFA Institute regional office in Hong Kong.