UK Investors Sound Warning on Voting Rights
Changes proposed by the FCA risk removing pressure from firms to perform and could encourage lack of accountability from management.
Institutional investors have stressed that the UK should not follow the US in the uptake of dual class share structures (DCSS), as a proposal from the Financial Conduct Authority (FCA) could make it easier for them to be used in the country.
DCSS are structures that allow companies to issue two different kinds of shares – where one type confers more power than the other, often resulting in the founder and executives carrying more voting weight than public investors.
Seven UK pension schemes led by Railpen published a letter on 21 June, in which they warned against the dangers of DCSS – such as the dilution shareholder rights – and how they could be detrimental to firm value and pension fund members’ benefits.
When companies use multiple classes of shares, the owners of certain share classes can benefit from superior voting rights disproportionately to their shareholding – meaning its executives can be insulated from market discipline of the market and the influence of its capital owners.
“For institutional investors like pension schemes, who have a fiduciary duty to invest in the best interests of [their] members, DCSS significantly dilute [the] ability to do so,” said Caroline Escott, Chair of the Investor Coalition for Equal Votes (ICEV). “This is because it [reduces] the impact of our vote – an important stewardship tool – making it harder to encourage better long-term performance and risk management at portfolio companies, and potentially leading to worse outcomes for everyday savers.”
Railpen has been focused on the DCSS issue for some time, having partnered with the Council of Institutional Investors – a non-profit association of US-based employee benefit funds – and several US pension funds in 2022 to create the ICEV, which campaigns to curb their use. In addition to chairing ICEV, Escott is acting head of sustainable ownership at Railpen.
“To be more appealing to companies, the UK should not attempt to become a watered-down version of the US,” warned Escott. “We should instead double down on what makes our listings regime unique — emphasising the UK’s appeal to investors by maintaining robust shareholder and voting rights and using this to support a proactive, positive case for our capital markets for high-growth companies.”
Safeguarding investor influence
The FCA’s proposal around DCSS is part of wider discussions around reforms to the UK listings regime, which aim to encourage a greater range of companies to list and grow on the country’s markets by making the regime more attractive to them and offering greater opportunities for investors – with the overall goal of boosting growth and competitiveness.
Only five UK-based companies currently use DCSS, which according to the watchdog means the proposed changes would only affect a very few companies and therefore limit additional costs to investors.
However, research released last year by the ICEV highlighted how the structure makes it difficult for independent shareholders to hold corporate decision-makers to account. It also showed that over time, firms with unequal voting rights are on average undervalued relative to their peers with a ‘one share, one vote’ structure when they go public.
In the letter, the asset owners cautioned that the FCA proposals risked making the UK less appealing as a destination for capital and drive up the cost of capital for UK-listed companies, as investors will require a higher return for the increased risk.
In addition, Escott noted that any potential financial advantages to DCSS tended to recede rapidly – within a few years after listing.
In a letter co-signed by 52 institutional investors including Railpen in February, the International Corporate Governance Network flagged global investors’ concerns that allowing dual-class shares with few investor protection safeguards could undermine the UK’s economic growth and attractiveness as a global financial centre, as well as expose investors to undue risk.
Permitting poor performance
DCSS have become more common in recent years, mostly among small companies and within certain industry sectors, such as technology, media and entertainment.
Companies including Alphabet, Berkshire Hathaway, Comcast, Meta, and News Corporation all use structures that give distinct voting rights to holders of ‘class A’ and ‘class B’ stocks. At Meta, class B stocks have ten votes per share while class A only gets one vote per share. As a result, although Meta founder Mark Zuckerberg only holds roughly 13.5% of the company’s total stock, his high number of class B shares means he holds more than 60% of shareholder voting power.
Escott highlighted the appointment of a director at Tripadvisor and an advisory vote on compensation at Pinterest as examples of DCSS that may have changed the outcome of an important vote during the 2024 AGM season.
Even the FCA’s consultation acknowledged potential drawbacks to the structure, saying more permissive rules – such as reduced risk of removal over an unlimited period or removal of a sunset clause – potentially meant management would not be as effectively disciplined. The watchdog also suggested listed DCSS companies would have less pressure to perform if the prospect of a takeover is diminished for a longer period – which could ultimately lead to poorer decisions.
“Specifically, we hope the FCA will bring in a mandatory time-based sunset clause of seven years or less on the use of DCSS, as well as reverse proposed changes to the current shareholder voting rights regime around significant and related-party transactions,” said Escott. “This would be a pragmatic response that recognises investors’ concerns and aligns with the evidence based around when any potential advantages are likely to disappear.”
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