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Too Uninformed to Vote? Research Says Non-Voting Shares Have Benefits

A new paper from the University of Chicago argues that issuing non-voting stock allows informed shareholders to acquire more influence at a lower cost.

Snap’s decision to go public with non-voting shares this year sparked opposition from institutional investors, ultimately leading at least two stock indexes to exclude companies with dual-class shares from their indexes. But the existence of shares without voting rights could actually be beneficial for activist investors, according to a new paper.

By limiting the number of shares with voting rights, dual-class shares put more power in the hands of informed investors who use their voting rights to maximize firm value, according to University of Chicago law professor Dorothy Shapiro Lund.

In the paper, Lund argued in favor of non-voting stock, saying it makes companies more attractive for both voting investors, who get more influence at a lower cost, and non-voting investors, who can get a discount in exchange for waiving their voting rights, as non-voting stock typically trades at a lower price.

“Not all shareholders value their votes equally,” she wrote. “Some, including retail investors, rarely vote at all. Others, such as hedge fund activists, accumulate shares to use their voting power to agitate for changes that would increase the value of their investment. And yet, the law compels corporations to bundle the right to receive corporate cash flows with the right to vote.”

Multiple share classes, Lund argued, can be used to “allocate voting power to informed and motivated investors who value their voting rights and are motivated to use them [to] maximize the firm’s value.”

In addition to retail investors, Lund cited passive funds as “weakly motivated voters,” due to the fact that passive funds seek only to match the performance of an index, not outperform it.

But some of the largest passive index providers have been increasingly engaging with companies on environmental, social, and governance issues. Vanguard Group announced last month that it increased its engagement by 39 percent between 2015 and 2016, while State Street Global Advisors is using its influence to pressure public companies to put more women on boards.

[II Deep Dive: The New Wave of Activists]

SSGA was also one of the firms that blasted Snap for limiting voting rights. In an interview with Institutional Investor earlier this year, Lynn Blake, SSGA’s chief investment officer of global equity beta solutions, called voting “a basic principle of shareholder rights.”

“With partial or no voting rights, is that really a public company?” she asked.

Lund conceded that companies like Snap that offer only nonvoting stock to the public become exempt from certain disclosure requirements and make it possible for “insiders” to ignore even informed outside investors.

Still, she argued that multiple share classes can reduce the risk of “suboptimal” outcomes for a public company, and that it’s in the best interest of both companies and investors to allow these dual-class structures.

“When optimal forms of structuring are taken off of the table, the result is corporate inefficiency and higher capital costs,” Lund concluded.

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