Supervoters, Stocks, and Silicon Valley: What Investors Should Know About Dual-Class Voting Structur

The financial world of investing is filled with mathematical complexity, from the quantitative analysis behind certain trading strategies to the calculus used to determine the pricing of derivatives. But investors in most publicly traded companies can rely on one rather simple ratio: 1-to-1.

That's the ratio that describes the voting structure at most companies: one share to one vote. An investor who owns one share may cast one vote, an investor who owns 10 shares may cast 10 votes, an investor who owns 100 shares may cast 100 votes, and so on, on everything from board member elections to ballots on whether the company should be sold. But that is only true in the so-called single-class share structure. In recent years, some high-profile IPOs have drawn attention to an alternative type of voting structure: dual-class voting structures. Under dual-class structures, certain shareholders get more voting power than others.

The "supervoters," as some call them, are typically company founders and management. The dual-class structure allows them to exercise disproportionate control over the company by allowing multiple votes for every share owned. For example, supervoters might receive 10 votes for every share owned while ordinary shareholders are still entitled to one vote per share.

A growing number of U.S. firms have adopted this structure: Between 2013 and late 2015, 98 companies newly listed on U.S. exchanges had dual-class IPOs, compared to 59 between 2010 and 2012, according to data from information provider Dealogic.

Among the most famous dual-class IPOs in the last few years have been tech firms, such as Facebook, Alibaba, and, most recently, FitBit. But the tech sector's game-changing foray into dual-class structures dates back to 2004, when Google launched its dual-class IPO, influencing future tech entrepreneurs in what The Wall Street Journal dubbed the "Google effect."

The ostensible rationale behind dual-class structures is that they allow company leaders (particularly those who retain controlling interests in their firms) more freedom to work toward important long-term goals without having their power challenged by shareholders who may be more interested in short-term gains. Before becoming in vogue in Silicon Valley, dual-class structures were largely the province of media companies that sometimes said that such structures were necessary to maintain journalistic integrity.

Whether dual-class structures are good or bad for companies and their investors is a long-running point of contention. Some argue that such structures let company managers have their cake and eat it, too by allowing them to retain control of their firms while raising more money than they could otherwise. Holding fewer shares of their own companies also leaves company leaders less vulnerable to risks should their decisions go awry, critics say.

Such "companies are sending the message that they want to control a majority of the votes but not take a majority of the risk," Matt Orsagh, director of capital markets policy at the CFA Institute, wrote last year. "Another way to say it is that they want the public's capital, just not their opinions."

Yet others argue that a company's top brass are right to be wary of investors who demand too much, too soon.

"Investors now have very short-term horizons. [...] When shareholders reckon in months (or weeks) rather than in years, it's harder for companies to take the long view," James Surowiecki, a financial columnist for The New Yorker, wrote about Facebook's dual-structure IPO in 2012.

Academic research on the subject produces conflicting findings.

In 1996, one study matched 98 dual-class firms with similar companies that had single-class structures. The researchers found that dual-class companies outperformed their single-class peers in both stock market returns and operating performance over a three-year period. A little over a decade later, a study of more than 500 dual-class firms found that their managers "are prone to waste corporate resources to pursue private benefits at the expense of shareholders."

For the individual investor, deciding whether to buy shares in a dual-class company is -- as with other investing decisions -- a matter of doing your homework as well as determining your personal preferences.

Consider the following: Do you approve of the way a company's "supervoting" leaders have steered the firm thus far? Are you comfortable with having disproportionate voting rights? Do you believe that the dual-class structure will serve the firm well in the future?

To determine a firm's voting structure, check media reports or its registration filings on the Securities and Exchange Commission's EDGAR database.

An Alert Investor is a smarter investor.

The article Supervoters, Stocks, and Silicon Valley: What Investors Should Know About Dual-Class Voting Structures originally appeared on Fool.com.

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