Share Classes of Common Stock
A class of common stock consists of all shares with identical rights; usually, share classes differ in the number of voting rights per share. Preferred stock is not a different class of common stock, but an entirely different type of security, more like hybrid debt.
Most companies issue common stock, each share having 1 voting right. But some companies issue different shares divided into different classes with different voting rights and is initially apportioned to different types of investors. The share class with the most voting rights is generally held by the founders and early investors, while shares with fewer or no voting rights are sold to the public. Share classes are typically called Class A, Class B, Class C, etc. However, the type of class designated by these names is not standardized, so the share class with the most voting rights may be Class A, which most people would assume, but it is often Class B. However, state corporation laws may require that certain issues be decided by the majority of stockholders, regardless of the voting rights of the shares that they hold.
Not all stock exchanges allow the listing of shares with no voting rights. For instance, Alibaba listed on the New York Stock Exchange instead of the Hong Kong Stock exchange because the latter, at least at the time of this writing, will not list stocks without voting rights.
The different share classes presumably have the same claim rights in equity, so if there is a bankruptcy, then they will have an equal claim to any remaining assets after creditors and the preferred stockholders have been paid. However, usually no equity remains after the completion of bankruptcy, so this claim right has little value for common shareholders.
Different share classes may also not be entitled to the same dividends — no law or regulation requires different share classes be entitled to the same dividends. However, to sell stock with no voting rights, the company may decide to add the requirement under their company policy. Snap, Inc., for instance, in its Form S-1 Registration Statement filing, states that all share classes will be entitled to the same dividend, but the same document states that the company does not foresee ever paying a dividend, so this entitlement may have no value.
Does Nonvoting Stock Have Any Real Value?
Nowadays, some companies are increasingly issuing shares with fewer voting rights than those held by the founders or early investors, such as Google (now part of Alphabet, Inc.), Facebook, Groupon, Shake Shack, and Alibaba. Class B Alphabet shares have 10 votes and are not publicly traded, Class A shares (GOOGL) have only 1 vote, and class C shares (GOOG) have no voting rights. Nonetheless, there is only a small difference between Class A and Class C prices. For instance, on 4/21/2017, GOOG (Class C) closed at $843.19, while GOOGL (Class A) closed at $858.95, a difference of slightly more than 0.1%. Closing prices for 10/16/2020: Class A: $1,573.01, Class C: $1,567.70. The difference in voting rights is even greater with Zynga, where the primary Class C shares have 70 votes per share, Class B shares, 7 votes, and Class A shares, the ones issued to the public, 1 vote. Issuing shares with fewer voting rights allows the founders and early investors to enjoy most of the benefits of company ownership while offsetting most of the risk to the investors of the lower-class stocks. For instance, Mark Zuckerberg holds 53.8% of Facebook's voting shares while owning only 15% of the company.
Some publicly issued shares have no voting rights at all. For instance, SNAP (the company ticker symbol) has only issued nonvoting shares to the public, while the founders and some early investors have retained the shares with voting rights. For instance, SNAP’s two co-founders, Evan Spiegel and Robert Murphy, retain 88.6% of the voting rights after their IPO. Zillow and Under Armour have also issued nonvoting shares. By issuing lower-class shares, founders and early investors can maintain control over their enterprise while using other people's money to finance the business. So they have majority control without the majority of risk, transferring that risk to the lower-class shareholders.
Is nonvoting stock really worth anything? Certainly, it is worth a great deal to the founders and early investors, since they can receive a lot of money from the public without giving much in return. Moreover, issuing share classes with fewer or no voting rights is an effective defense against hostile takeovers and activist investors. But public shareholders are receiving very little value for their money. Furthermore, if the company suffers, then the holders of the lower-class shares cannot hold the management accountable, since they have little or no influence on corporate governance.
If the stock never pays dividends, then the only potential profits earned by the buyers of the stock will only come from someone else willing to pay a higher price. What if the company flounders, and the founders seek to sell the company? Any buyer of the company would have no interest in the nonvoting stock, since it has no value in owning and controlling the corporation. Instead, all the money would be paid to the founders and certain other investors who have voting shares, if they were willing to sell.
Another way that lower-class investors can lose is if the higher class stockholders only issue dividends for their own stock. the founders can simply declare dividends for their class of stock to receive income at lower tax rates, but they have no real incentive to declare dividends for the nonvoting stock, since once they have issued the nonvoting stock, they have already gotten their money, and any subsequent sales would be between traders. So issuing dividends on the nonvoting stock would just drain the company of money and lower the value of all the shares of stock including the primary class, since the company would have less money. On the other hand, if the primary class holders issue dividends on their own stock only, then, that too, will lower the value of all the classes of stock, including the stock of the lower-class holders, since it will lower the value of the company, but the lower-class holders would not receive anything in return for the lower value. Likewise, the company would never repurchase its own nonvoting shares, so the stockholders will not even benefit from a stock buyback.
Ironically, index funds will give nonvoting stock some value, since they will buy the stock to track their index, but, without voting rights or rights to dividends, the stock has no intrinsic value. A higher price may also result from limiting the amount of stock available to the public, at least immediately right after the IPO, so that the initial investors will not feel they got duped, which could lead to bad publicity.
Eventually the founders or early investors will die, or they will sell if the business flounders. Who then gets the shares? Will the new owners have the same passion or business acumen? Any buyers of the business will only be interested in the shares with the most voting rights and will have no interest in shares without voting rights. Indeed, if the business does flounder, then the shares of stock with no voting rights will probably drop to 0, even if the business still has significant value, since any potential buyer will not have any interest in buying nonvoting shares.
As can be seen from the stock market prices, nonvoting shares in Google trade at only a slightl discount from the shares with 1 vote. Nonetheless, even at those prices, the nonvoting shares are probably overpriced, since there is no guarantee that they will ever have any value, even if the company continues to be wildly successful. Even stock with some voting rights may still have little value if most of the voting rights are held by a few individuals. For instance, if Mark Zuckerberg wanted to sell Facebook, he would get all the money, since by buying his shares, the new buyer would have complete control of the company, without paying a dime to any other investors! Stockholders sometimes profit when some investors try to control a company by buying shares over time, but this tactic will not work when a few investors hold share classes with most of the voting power, so they will never gain enough shares to have effective control over the company. Hence, there will be no incentive to buy such shares, another disadvantage to holders of shares with fewer or no voting rights.
If investors keep showing an interest in buying the nonvoting shares, then many new companies will increasingly turn to issuing nonvoting shares, since it will allow them to maintain both control and to keep most of the value of the company to themselves while offsetting most of the risk to the public shareholders. What a deal — for the founders and early investors! It will allow them to fund their enterprise with public money, yet control it like a private company!
Some companies that maintain the official indexes have also decided that stocks with fewer or no voting rights are a bad deal for investors.
FTSE Russell, which includes the Russell US indexes and FTSE Global Equity Index Series, will require, as of September 2017, that public investors must have a minimum 5% of the voting rights. This 5% threshold will affect 183 companies in the index, including SNAP. In the United Kingdom, the FTSE Russell requires a 25% threshold. Companies already in the index will be given 5 years, until September 2022, to conform to the new requirements; else they will be removed from the index. However, the FTSE Russell is still evaluating what the best policy is, so this may change in the future.
S&P Dow Jones — which includes the S&P 500, S&P MidCap 400, and S&P SmallCap 600 — is going further, barring companies with multiple share classes from their indexes. No new companies with multiple share classes will be added to the index, but those that are already included will remain.
Because many shares of stock are bought because they are part of an index, these new policies will deter future companies from issuing multiple share classes as a means of taking advantage of public investors.