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RHTLaw Taylor Wessing Managing Partner Tan Chong Huat and Head of Capital Markets Ch’ng Li-Ling authored an article titled “Managing the pros and cons of dual-class listings a balancing act” for The Business Times.
The article was first published in The Business Times dated 7 September 2016.
Managing the pros and cons of dual-class listings a balancing act
Singapore Exchange will need to carefully assess the requirements that should be imposed on companies seeking to list a dual-class share structure here.
Source: The Business Times © Singapore Press Holdings Ltd.
Date: 7 September 2016
Author: Tan Chong Huat & Ch’ng Li-Ling
THE investment and business community has lately been abuzz with reactions to the recent move by Singapore Exchange (SGX) to consider the listing of dual-class shares. In its 2016 annual report, SGX revealed that “an overwhelming majority” of the members of its Listing Advisory Committee (LAC) voted in favour of permitting the listing of dual-class shares although this was qualified by the need to implement the relevant corporate governance safeguards to mitigate the inherent risks associated with a dual-class share structure.
This is a timely update from SGX, following the amendment to the Singapore Companies Act which took effect in March this year, that enables a public company to issue different classes of shares if the company’s constitution allows for such issue and if it sets out, in respect of each class of shares, the rights attached to that class of shares.
The following briefly sets out the pros and cons of the listing of a dual-class share structure and considers some of the safeguards that may mitigate the risks.
THE CASE FOR THE LISTING OF DUAL-CLASS SHARES
Founders preserve power while getting access to capital
For founders, a dual-class share structure retains some of the positive aspects of being a private company – it allows founders control over significant decisions of the company, while allowing them to access the equity markets for additional financing for the company.
A dual-class share structure which has multiple votes for founder shares may also protect a company from hostile takeovers and act as a takeover defence mechanism.
There is more flexibility in capital management and encourages innovation and the pursuit of long-term growth
A company has greater flexibility in raising capital by issuing non-voting shares and shares with multiple votes.
With control, the founders and management are afforded a certain degree of autonomy in strategic decisions, have the freedom to innovate (that is, take more risks) and are better able to focus on long-term growth, instead of being under shareholders’ pressure to deliver short-term financial returns.
For example, in Google’s initial public offering letter, the founders highlighted that its share capital structure (under which the founders and management had 10 votes per Class B common stock compared to Class A common stockholders with one vote per share) was designed to protect Google’s ability to innovate and to retain its distinctive characteristics; and while the Class A common stockholders would fully share in Google’s long-term economic future, they would have little ability to influence Google’s strategic decisions through their voting rights.
THE CASE AGAINST THE LISTING OF DUAL-CLASS SHARES
Bad management is insulated from market discipline, and problem of the “next generation”
A dual-class share structure allows disproportionate control over a company, and shields a bad management from market discipline as shareholders and “white knights” hoping to make a corporate rescue will find it more difficult to remove the owner-management. In Singapore, there is also not yet an activist shareholder culture, compared to a market such as the US that can keep the management in check.
There is also the uncertainty of the “next generation”, when the founder retires and hands over the management (and weighted shares in the company) to his next generation, who may not drive the business as successfully.
Risk to corporate governance structure and agency problem
A dual-class share structure also exposes the company to the risk of the owner-management pursuing goals that are not in the interests of the company or the public shareholders. There may also be heightened risks in accounting and financial controls and in the prevalence of related or interested person transactions.
When such a company is poorly managed, the perceived agency problem may ultimately be reflected in higher cost of capital when the company raises further financing.
The minority public shareholders may be disenfranchised
The dual-class share structure limits investors of their voting rights and, consequently, their ability to participate in shareholders’ meetings.
While there are statutory protections under the Companies Act to protect the interests of minority shareholders, the costs of litigation and the dearth of local case law on derivative actions brought against public companies are drawbacks that may prevent them from seeking recourse.
With no or limited mechanism by which to effect change or to voice their opinions, shareholders would simply feel forced to sell and exit. If such a problem becomes prevalent in the stock market, it will in turn affect investor confidence and adversely affect the perception of our stock exchange.
MITIGATING THE RISKS AND PROPOSED SAFEGUARDS
The Companies Act contains basic safeguards as follows:
(1) A public company shall not issue shares that confers special, limited or conditional voting rights or no voting rights, unless the issuance is approved by members by special resolution.
(2) Where a public company has one or more classes of shares that confer special, limited, conditional or no voting rights, the notice of any general meeting required to be given must specify the rights (or the absence of rights) in respect of each such class of shares.
(3) Holders of non-voting shares should be accorded at least one vote on a poll at a meeting of the company for a resolution to voluntarily wind up the company under section 290 of the Companies Act or a resolution to vary any rights attached to the non-voting shares and conferred on the holders.
The additional safeguards for public listed companies may include:
permitting only companies with a large market capitalisation, such as a high minimum valuation to be eligible for the dual class share structure;
restrictions on transfers;
cap on votes per share;
loss of superior voting rights after a vote by independent shareholders; and
board structure with a greater proportion of independent non-executive directors.
The above safeguards were considered by the Hong Kong Stock Exchange (HKSE) when it reviewed a proposal to allow the listing of dual-class shares and may be further examined.
Other safeguards may include a “sunset provision” for founder shares with multiple votes, where the rights to multiple votes terminate after a specified period of time or upon the occurrence of a specified event (for example, where the founder retires or transfers his shares).
In addition, it may be appropriate to require the appointment of a compliance officer to further strengthen the independent director regime under our Code of Corporate Governance. The authors believe that each of these and other safeguards proposed by the LAC may be further enhanced or tweaked depending on the LAC’s holistic assessment of the listing aspirant, for example cap on votes per share.
It is noteworthy that despite the recommendations of the HKSE, the Securities and Futures Commission of Hong Kong (SFC) rejected HKSE’s draft proposal as the (i) high expected market capitalisation does not guarantee that an issuer would treat its shareholders fairly, and (ii) the “enhanced suitability” criteria proposed by HKSE to determine which listing applicants are eligible to adopt the dual-class shares are subjective and vague, which can lead to regulatory uncertainty and inconsistent and unfair decision-making.
The concerns by the SFC are valid and in our case, SGX will need to carefully assess the requirements that should be imposed on companies seeking to list a dual-class share structure in Singapore. It will be a delicate balance between the need to remain competitive and relevant in an evolving global landscape, the need to be able to effectively mitigate the increased governance risks in the market, and the need to remain true to the general principles of the listing rules which require, among others, the fair and equitable treatment of shareholders.