Improving Dual-Class Company Regulation Under COVID-19 Pandemic

Associate Professor Xiao-chuan Weng

There is an increasing number of high-tech and innovation companies incorporating in a dual-class share structure globally. In the past two years, jurisdictions such as Singapore and Hong Kong have allowed the structure. This discussion briefly considers whether it is time to adopt dual-class structures in capital markets in Australia. Permitting dual-class companies to access public financial markets can speed high-tech start-ups in facilitating their capital demands to respond to the COVID-19 pandemic appropriately. Further, it may attract already successful high-tech and innovation firms, such as Alibaba and Google, to issue shares in Australia to benefit the Australian economy.

Dual-class structures usually include two classes of shares: a class with normal voting rights and a class with enhanced voting rights class. The latter class very often enables the founders of the company to maintain tight control over the firm with less capital contribution. While the structure might bring more problems for investors, many jurisdictions have allowed dual-class companies to float on stock exchanges under the pressure of international market competition and the cultivation of start-ups. Australia currently does not support dual-class companies to be listed on its exchange, partly because the market is not very familiar with dual-class structures and also there is some concern about new agency problems that the structure can invite.

Under the current COVID-19 pandemic, the world needs high-tech and innovation companies. High-tech and innovation companies not only facilitate productive activities when cities are in lockdown, and people cannot physically work together; they are also a significant hope for the entire world to find the cure to the pandemic. A dual-class share structure has been preferred by high-tech and innovation companies recently. The number of listed dual-class companies has grown in recent years. Therefore, it is imperative and worthwhile to pay more attention to the rising star of the business organisation family.

As a dual-class share structure can result in situations where investors get hurt under current investor protections, promulgating a set of specially drafted dual-class company regulations is indispensable to allowing dual classes of shares. The first legal response, of course, is to protect public investors from misleading information or help them to price the stocks in a firm correctly. Many countries, such as the US and Singapore, have decided only to allow dual-class structure at the initial public offering (IPO) stage. Companies after IPO usually cannot create dual-class structures in recapitalisation. It is because it is still not clear if permitting it will enhance the shareholder's value. The opponents of recapitalisation to create a dual-class company worry about whether the ex-post change will entrench the management from takeover, which hurts the firm's value. The value effect of the structural change might not be evident for investors in order to correctly price the project. However, it seems the structure is not harmful if the post-IPO recapitalisation is for maintaining existing control.  Given that market regulators have for a long time held unwarranted fear towards dual-class companies, it is not surprising that most of the jurisdictions allowing the structure are reluctant to allow recapitalisation as an alternative to dual-class voting structures.

The second issue is treated differently in different jurisdictions: should every IPO company be able to choose the dual-listed structure? HK and Singapore, for instance, are jurisdictions that stipulate many conditions in selecting “qualified industry” companies for IPO dual-class structures. However, the US is an exception in this respect. NYSE and NASDAQ allow companies to apply for a dual-class structure in any industry.  Even if allowing dual-class structure companies to access capital markets is a questionable decision, it can be predicted the markets around the world will be opening up to the structure under the pressure of global inter-financial market competition. Hong Kong (HK), for instance, explicitly requires that IPO dual-class structure companies must be technological and innovation firms. Singapore has a relatively ambiguous attitude on the industry-specific requirement and asks IPO dual-class structure companies to show some fast growth potential. These new rules are designed for the "new economy" consideration. 

Thirdly, the requirements for dual-class structures are not limited to businesses having technology and innovative features, but also expand to many other IPO and corporate governance aspects. From IPO requirements perspective, HK has a relatively higher hurdle on financial statuses, such as net worth and net earnings.  Most other jurisdictions have quite relaxed conditions on IPOs from the perspective of financial status. Compared to encouraging and incubating high tech start-ups, Hong Kong focuses more on not losing mature firms such as Alibaba to other capital markets. The US, for example, is more interested in not only keeping the mature tech superstars but also assisting firms in an incubational stage to get finance.  

The last response to dual-class structures is introducing a sunset rule to restore a “one share one vote” structure after a given period, assuming that the benefits of DCS structure attenuated or the reduction of the management capacity of firm controllers that dampens the value increasing effects of the structure. Triggering event sunset and ownership percentage sunset rules has been widely adopted across dual-class structure friendly jurisdictions, but fixed-term sunset rules have not. It seems regulation on event-based and ownership-based sunset rules have some justifications to avoid incapable parties at their helm. The most compelling justification across the world for allowing the dual-class structure to be used is that investors appreciate the founder/controller’s highly firm-specialized knowledge, which can significantly add value to the firm. Once the founder/controller transfers the control to an outsider, it becomes pointless to continue to grant such a voting right deviation in exchange for the uncertain managerial benefit. Although installing a fixed-time sunset rule receives much support from academia, it is still a very controversial issue and so far, strictly speaking, no jurisdiction has made a sunset rule mandatory for listed dual-class structure companies.