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The Downside of the Market's Class System

The Downside of the Market's Class System

Photograph by Andrew Harrer/Bloomberg

When a company goes public, it must tell shareholders how it plans to govern itself. The new owners are promised a piece of the profits and a say in how the company is run. The standard arrangement for apportioning control is “one share, one vote.” That’s a good, tried-and-tested design, but it seems to be going out of fashion.

Planned initial public offerings by two large Internet companies, Twitter and Alibaba Group Holding, are putting a spotlight on dual-class ownership, which gives certain shareholders fewer voting rights or none. Dual shares, often known as Class A and Class B stock, until recently were out of favor, but they are making a spectacular comeback, especially among technology companies. Google (GOOG) led the way with its 2004 IPO, followed by LinkedIn (LNKD), Groupon (GRPN), Zynga (ZNGA), and Facebook (FB), which all have two or more share classes.

It’s a trend investors would be wise to resist. Institutional Shareholder Services found that, from 2002 to 2012, companies with multiple share classes underperformed their peers over three-, five- and 10-year periods. They also showed greater stock-price volatility, weaker accounting controls, and more conflicts in business dealings.

The founder of Alibaba, the Chinese e-commerce giant whose value could exceed $100 billion, at first wanted to list on the Hong Kong Stock Exchange, but that market doesn’t allow dual-class shares, so Alibaba is coming to New York. Both the New York Stock Exchange (NYX) and Nasdaq (NDAQ) allow companies to have unequal voting rights. For now, Twitter will offer a single class of shares, but the company says it reserves the right to switch to two classes.

Google, Facebook, and the rest aren’t likely to return to “one share, one vote” anytime soon. That shouldn’t stop exchanges concerned about their reputations and corporate governance standards from leaning against the fashion—perhaps by limiting dual classes to the first five years of public ownership, or capping nonvoting stock at, say, 25 percent of all shares. For investors, the best advice is the same as always: Buyer beware.

To read Ezra Klein on and Caroline Baum on why economics isn’t a science, go to:

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