Understanding Dual Class Shares

What is the history of dual class shares?

The rise in dual-class share structures can be traced back to the 1970s when media and telecommunications companies were getting established under the Canadian Radio-television and Telecommunications Commission. Because a limited supply of broadcasting licenses were involved, most companies were subject to foreign ownership restrictions. Two classes of shares was one way of raising equity in outside markets while retaining control of the company in Canadian hands.

What are dual class shares?

Dual class shares are two classes of shares issued by a company. Each class is either a voting share or a non-voting share. This means that only the voting class will have a say in the appointment of directors or a vote in any other meaning full decision to be made by the shareholders. The non-voting class shares do not participate in the decision making process of a company, they simply are a class that participate in the earnings potential of the company and receive dividends if they are paid. Non-voting shares allow for companies to raise capital without losing any control in essence.

What type of dual class shares are there?

Generally there are three types of dual class shares. One is where there are voting shares, with one vote per share, and the other class is classified as non-voting. The second common type is super voting shares and regular one vote shares. The super voting shares gives the holder more than one vote per share. An example is Magna founder and Chairman Frank Stronach ultimately controls 74 per cent of the vote for the price of less than 1 per cent of the equity. The third type is a voting and multiple voting class, so a class with one vote and another class (multiple) with 10 votes for example.

All types give the owners of voting, super voting or multiple voting class shares control of the company.

In some cases both classes of shares trade on the stock exchange. In other cases only the non-voting or subordinate voting shares trade while the voting or multiple voting shares are privately held.

Why do some companies use a dual class structure?

There are two views on this. The detractors and the supporters.

To detractors, having a dual class share structure is about maintaining control. They point out those owners of the voting shares have more power and can entrench poor management and insulate them consequences from bad decisions they may have made. Also, dual class shares allow for owners/management to keep an iron grip on the company while putting up less than a majority of the equity. This creates the separation between those who put up the money and take the risk and those who don’t own much of the company but have the controlling votes.

Supporters of dual class shares, usually the owners of such, reason that dual class shares protect a company from any unwanted take-over bids because the founders/management control the voting shares and would not allow a take-over bid to occur. This, they say, ensures the stability of the board and management and therefore investors don’t need to worry about change in power at the top. Founders/Management has a longer term vision for the company than investors who are focused on immediate profitability that could undermine the long term success of the company.

Can you name some of the companies that use a dual class share structure?

I’ll name some of the larger well known companies but many other companies listed on the TSX also have a dual class structure.

ATCO

Bombardier

CHUM

Canwest

La Senza

Magna

Onex

Quebecor

Jean Coutu

Shaw

Telus

Evidently, not just telecommunication companies are using dual class shares today.

Are there any differences in liquidity and premiums for dual class stocks?

When looking at Non-voting and a voting share dual class structure, where both types trade on the exchange, non-voting shares seem to have much more liquidity. This is probably due to the owners of the voting shares not willing to give them up. And there are typically a much larger number of the non-voting or subordinated voting shares. Of course, with less liquidity the bid / ask spread for voting shares is much larger.

Another common characteristic of this type of dual class structure is a price premium for the voting shares. Some voting shares have a very large premium relative to non-voting shares.

An example of liquidity and premium difference can be found with the dual class structure of CHUM. They have voting and non-voting shares trading on the TSX. CHUM voting shares have a negligible volume of shares trading daily whereas the non-voting shares have an average daily volume of over 50,000 shares traded. The non-voting was recently trading around $28.65 whereas the voting shares are trading at $38.50. A $10.00 premium for the voting shares. Interestingly, this is much large than the usual historic premium, as the graph indicates.

Let’s graph the differences in price movement and liquidity for CHUM.
dual_c1
dual_c2

Note that the volume of the voting shares is almost invisible on the graph. It is quite evident that the non-voting shares have much more liquidity but are punished with a price discount for not having a vote in the affairs of the company.

Which Class should an Investor buy?

This depends. The best advice is usually to buy shares with good liquidity. Usually the non-voting shares have the greater liquidity. However, if you are put off by owning shares that don’t give you a vote in the company maybe the voting share is best for you. That being said, a voting share with non existent volume may require you to hold on to these shares for a very long time. The bid / ask spread is also typically higher on the voting shares, and this can cost you money. To buy the voting you usually have to pay the asking price, but if you want to sell you can only get the (lower) offered price.

Also realistically, for small investors there is no chance to influence the company through your vote. If the chance to vote is realistically pretty meaningless to a small retail investor, then it makes little sense to buy the voting shares at a higher cost. However, if at a particular point in time the voting share is the
same price as the non-voting and if the buyer is committed to holding for a long time, then it might make sense to buy the voting, since its price could subsequently rise above the non-voting.

Class merger may be another reason to purchase one class over the other. For example, if there is the possibility of the merger of the classes you may want to purchase the non-voting share because the premium on the voting class may evaporate.

Arbitrage between the two classes may yield profits but there must be liquidity and the investor must be aware what a normal spread between the two share classes is. Determining if the spread will tighten or widen will decide how to execute the arbitrage. If the spread is expected to tighten then shorting the class with the price premium and buying the other class will yield gains. If the spread is expected to widen then the opposite arbitrage maneuver will yield gains. Looking at the CHUM price graph, it is evident that the spread is abnormally large and may be a candidate for arbitrage with the spread narrowing. However, arbitrage is a very complex financial maneuver and is best left to the experts.

In conclusion.

Dual class shares seem to be very unfair. They create a second class shareholder with no voice as to the direction the company can take. Saying that, the majority of (voting) shareholders have no real say because individually they hold a small fraction of shares outstanding. In buying either class of shares, investors should first look at both classes before deciding which to buy should consider the likely hood that the voting shares will rise more rapidly, the chance that the controlling management will somehow abuse the non-voting shareholders, the realistic value of the right to vote, the impact of the lower liquidity on the voting shares, the probability that the investor will want to trade the shares, the impact of the usual higher bid / ask spread on the voting shares, and the current premium on the voting shares versus the historical premium.

Ultimately, by owning non-voting shares the investor is placing a bet on management to make the right decisions to ensure long term profitability of the company. However, those who control the voting shares normally have an interest in maintaining a good reputation with investors. All the same, investors should keep in mind the effects of dual-class shares on liquidity, any premium difference and possible mishandling of the company from bad decisions which would affect both classes.

END
InvestorsFriend Inc.
February 5, 2006

Leave a Reply

Your email address will not be published. Required fields are marked *

Scroll to Top