1 Legacy of One of the Biggest Financial Swindlers

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You may own shares of Facebook  (NASDAQ: FB  ) , but your shareholder vote doesn't mean a whole heck of a lot. It shouldn't surprise you to hear that, after all, Facebook is perfectly clear in its filings that its dual-class share structure gives 10 votes per share to B-class (insider) shareholders. Holders of the A shares get a measly single vote per share.

As put in Facebook's 10-K:

Because of the ten-to-one voting ratio between our Class B and Class A common stock, the holders of our Class B common stock collectively control a majority of the combined voting power of our common stock and therefore are able to control all matters submitted to our stockholders for approval...

Not that it's fair to pick on just Facebook. At Google  (NASDAQ: GOOGL  ) , Larry, Sergey, and Eric own the lion's share of the 10-votes-per-share B-class shares and effectively control the company through that ownership. Zynga  (NASDAQ: ZNGA  )  has three classes of stock, with C shares carrying a whopping 70 votes per share. Mark Pincus effectively controls that company through this tri-class structure.

And, really, we could continue down the list because there is no shortage of companies -- particularly tech companies -- that have this sort of multiple-class, "I own a little, but control most" share structure.

Now there are those who will argue vehemently in favor of this kind of setup. For instance, earlier this year, Andreessen Horowitz managing general partner Scott Kupor wrote for Forbes that "Dual Class Shares Are A Founder's Best Friend."

Kapur made some great points in his article, including:

Great founders of successful technology companies find and exploit product cycles -- e.g., Jeff Bezos (Amazon  (NASDAQ: AMZN  ) ), Bill Gates (Microsoft  (NASDAQ: MSFT  ) ), Steve Jobs (Apple  (NASDAQ: AAPL  ) ) -- to the benefit of long-term shareholder appreciation... Investing in a product cycle increases short-term R&D expenses and thus reduces near-term earnings. Short-term investors don't like this -- and generally can't see what the innovator so plainly sees in the future. 

In other words, tech company founder/CEOs need the protection of a dual-class share structure to protect themselves from marauders like Carl Icahn -- see, for instance, the aforementioned's current campaign targeting Apple. Without that protection, they'll be beaten into short-term-focused mediocrity by outside investors.

That's a reasonable argument. But if you're considering investing in a company with a dual- (or tri) class share structure, consider this tidbit I recently picked up from Frank Partnoy's The Match King: Ivar Kreuger, The Financial Genius Behind a Century of Wall Street Scandals: It was none other than the epic financial swindler Ivar Kreuger who introduced the use of dual-class share structures. 

In the case of Kreuger, the thinking behind a dual-class structure was simple: He wanted investors' money and he didn't want there to be any risk of anyone else having enough power to question his crooked empire. 

Not that I'm in any way suggesting that Sergey and Larry over at Google are trying to keep investors away from financial skeletons in their Mountain View closet. At the same time, I don't think too many investors would be comfortable with companies adopting aspects of Bernie Madoff's infamous empire. The dual-class structure has gained some amount of credibility over the years, but it's hard to say it has any other than dubious roots.

Perhaps that sounds a little too snarky and you do see the merit in allowing founder/CEOs to maintain control while still selling shares. In that case, consider this: In the quote from Kapur above, he notes the need for developmental leeway for the technological visionaries at Amazon, Microsoft, and Apple. Yet, none of those companies have dual-class structures. Of that trio, Amazon is a particularly illuminating example as with a single class of shares, investors have given Bezos an almost unbelievable amount of leeway for well over a decade to eschew ringing up profits in an effort to grow the company and establish maximum market penetration.

Far be it for me to argue that you shouldn't consider ever investing in a company with dual-class shares. Certainly avoiding Google for that reason would have been a mistake. But I also wouldn't suggest ignoring what it means when a company chooses that route -- that is, that they're happy to take investors' money but want no input from those new owners.

Dual-class shares were a good move for Ivar Kreuger, but they may not be as great for today's investors.

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  • Report this Comment On October 24, 2013, at 9:27 PM, dbtheonly wrote:

    The stock watering games of the 19th Century & the manipulations of the 1920's make for interesting reading as well. Makes you appreciate Bill Douglas & the SEC

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