It is not unusual to find companies issuing dual class of shares, one
having voting rights and the other having limited or no voting rights.
Issue of non-voting rights shares breaches the fundamental right of the shareholders. Equity investors are effectively the owners of the business having certain advantages over providers of debt capital. These include entitlement to: receive dividends, attend meetings, participate in new issue of shares to protect dilution, receive reports, residual claims (including undistributed profits) on the assets, and vote on the important matters.
If any of these advantages are taken away from the shareholders it will not be considered fair. Imagine where a company issues new shares to some private institutions thereby creating dilution for the existing shareholders, or where (more serious) a company does not pay dividends to certain group of shareholders. When such things happen it is natural to question the integrity of the management. Despite this, plenty of instances, albeit of less serious kind, are available in the corporate world.
Let us concentrate on issue of non-voting shares. Just why the management would want to do this? The main reason as it appears is that the majority shareholders want to retain or increase their control in the business. Furthermore, they may also want to protect themselves from a (hostile) takeover by an outsider. It seems like a noble thought, but only if taken in the right spirit. It is one thing when there is a well run company which is under a threat of takeover and another thing altogether when there is a show of only the majority power.
Under the circumstances what should the minority shareholders do? Well, it depends on what they are looking for. Usually a company develops its own clientele when it comes to the type of shareholders. For instance, a high dividend paying company will have shareholders looking for stable income such as pension funds and retirees. A high growth company not paying dividends will have shareholders looking for long-term growth and capital appreciation.
Similarly, when a company issues non-voting shares it is conveying a message, and therefore it is appropriate for only those investors who are happy with the present management having control on a long term basis.
Let us look at this way: Generally when you buy a stock, you are not going to look for having control and running the business. Instead, you will look at the business and management, and its past record and future prospects before the purchase. The right to attend meetings and vote on the important matters is only secondary as usually management will have a majority voting due to its higher shareholding. Therefore, the investor’s participation in voting does not matter much and the investor knows it. If the purchase of a stock is for the right purposes, that is, to participate in the business and its profits, the correct way to look at is to see whether you are comfortable with the present management and the way they have run the business. If not, there is no question of buying that stock. Why would you buy a share in the business if you are not happy with the way it is operated?
If this argument is true, why would you be bothered whether you have voting rights or not? Good management brings forth good results and eventually, good market value anyway.
In another situation, let us say, you are already a shareholder in a business and now note that the quality of management has deteriorated and you are worried about it. You have a few choices to make: 1) sell the shares – this depends on the prevailing market price versus the price you paid for the stock; 2) do nothing – but pray for the better sense to prevail upon the management; 3) do something to change the management so that the business is run more efficiently.
Now, if you have full voting rights, how can you ensure change in management? You have to hope that some hostile takeover takes place to overthrow the majority shareholders. However, for that to happen some shareholders will have to sell to these activists – majority shareholders (present management) will not do that. The only way is a large group of minority shareholders to sell their shares and exit. If that takes place you as the remaining shareholder will benefit after takeover and change in management. The question is – will you want that? What if all minority shareholders are like you and wait for others to sell? That is why those voting shares will trade at a premium over non-voting shares. The activists will be more willing to pay a higher price to acquire control. The higher the premium, the more likely that voting shares will be sold.
If we consider these arguments, the value of non-voting rights becomes a bit clear. In most situations there will be no difference between the (intrinsic) value of voting and non-voting rights shares; none. This is true whether the business is good or bad, or whether the management is efficient or not.
Only in those rare situations where there is a high probability that a change in management will take place and business is likely to be run more efficiently, the value of voting rights shares will be higher.
But the catch is, the shareholder having voting shares will be able to sell to the activists at a premium but will not be able to participate in the prospects of a now more efficiently run business. It is then the remaining shareholders – both voting and non-voting rights – who will benefit from the new management. From that point again there will be no difference between the value of both classes of shares.
Voting rights never matter to an ordinary shareholder except when those can be sold at a premium.
Assume this: There is a business with current market value of 10000 m. This value will change to 15000 m if it is run more efficiently. It has 250 m voting rights shares and 400 m non-voting rights shares. There is about 25% probability of change in management for better.
In this situation, corporate finance will give a control premium value for voting rights shares as follows:
Value of non-voting shares = 10000 / 650 = 15.38 per share;
Value of voting shares = 0.25 * 5000 / 250 + 15.38 = 20.38 per share
While voting rights share will have a premium, it will be difficult to calculate unless there is a high probability of change in management. A mere 25% probability will look good in theory; in practice, it will still mean a low probability of change. Only when there is a very high probability the voting rights shares should trade higher. If not, both classes should trade more or less at similar price.
When there is a very high probability of change the (maximum) value of voting rights can be in the region of (assuming business values are accurate): 5000 / 250 + 15.38 = 35.38. This appears very high compared to the non-voting shares because this example assumes far lower number of voting shares and about 50% higher new value of business.
To conclude, the investors should consider (of course among other things) only the quality of management before deciding to purchase any stock, irrespective of voting rights.
1) If voting shares of a good business (good management) are trading much higher than non-voting shares, it is far better to buy non-voting shares.
2) It does not make sense to buy any shares of a bad business (bad management) whether voting or non-voting rights.
3) A shareholder of a business with deteriorating management should estimate chances of change in management for better and if such chances are high, both voting and non-voting shareholders should do nothing.
Note that the change will happen only if some voting shareholders sell. They will need to sell (of course at a premium) to facilitate the change in management and increase the prospects of the business and its shareholders (both voting and non-voting) who did not sell.
Issue of non-voting rights shares breaches the fundamental right of the shareholders. Equity investors are effectively the owners of the business having certain advantages over providers of debt capital. These include entitlement to: receive dividends, attend meetings, participate in new issue of shares to protect dilution, receive reports, residual claims (including undistributed profits) on the assets, and vote on the important matters.
If any of these advantages are taken away from the shareholders it will not be considered fair. Imagine where a company issues new shares to some private institutions thereby creating dilution for the existing shareholders, or where (more serious) a company does not pay dividends to certain group of shareholders. When such things happen it is natural to question the integrity of the management. Despite this, plenty of instances, albeit of less serious kind, are available in the corporate world.
Let us concentrate on issue of non-voting shares. Just why the management would want to do this? The main reason as it appears is that the majority shareholders want to retain or increase their control in the business. Furthermore, they may also want to protect themselves from a (hostile) takeover by an outsider. It seems like a noble thought, but only if taken in the right spirit. It is one thing when there is a well run company which is under a threat of takeover and another thing altogether when there is a show of only the majority power.
Under the circumstances what should the minority shareholders do? Well, it depends on what they are looking for. Usually a company develops its own clientele when it comes to the type of shareholders. For instance, a high dividend paying company will have shareholders looking for stable income such as pension funds and retirees. A high growth company not paying dividends will have shareholders looking for long-term growth and capital appreciation.
Similarly, when a company issues non-voting shares it is conveying a message, and therefore it is appropriate for only those investors who are happy with the present management having control on a long term basis.
Let us look at this way: Generally when you buy a stock, you are not going to look for having control and running the business. Instead, you will look at the business and management, and its past record and future prospects before the purchase. The right to attend meetings and vote on the important matters is only secondary as usually management will have a majority voting due to its higher shareholding. Therefore, the investor’s participation in voting does not matter much and the investor knows it. If the purchase of a stock is for the right purposes, that is, to participate in the business and its profits, the correct way to look at is to see whether you are comfortable with the present management and the way they have run the business. If not, there is no question of buying that stock. Why would you buy a share in the business if you are not happy with the way it is operated?
If this argument is true, why would you be bothered whether you have voting rights or not? Good management brings forth good results and eventually, good market value anyway.
In another situation, let us say, you are already a shareholder in a business and now note that the quality of management has deteriorated and you are worried about it. You have a few choices to make: 1) sell the shares – this depends on the prevailing market price versus the price you paid for the stock; 2) do nothing – but pray for the better sense to prevail upon the management; 3) do something to change the management so that the business is run more efficiently.
Now, if you have full voting rights, how can you ensure change in management? You have to hope that some hostile takeover takes place to overthrow the majority shareholders. However, for that to happen some shareholders will have to sell to these activists – majority shareholders (present management) will not do that. The only way is a large group of minority shareholders to sell their shares and exit. If that takes place you as the remaining shareholder will benefit after takeover and change in management. The question is – will you want that? What if all minority shareholders are like you and wait for others to sell? That is why those voting shares will trade at a premium over non-voting shares. The activists will be more willing to pay a higher price to acquire control. The higher the premium, the more likely that voting shares will be sold.
If we consider these arguments, the value of non-voting rights becomes a bit clear. In most situations there will be no difference between the (intrinsic) value of voting and non-voting rights shares; none. This is true whether the business is good or bad, or whether the management is efficient or not.
Only in those rare situations where there is a high probability that a change in management will take place and business is likely to be run more efficiently, the value of voting rights shares will be higher.
But the catch is, the shareholder having voting shares will be able to sell to the activists at a premium but will not be able to participate in the prospects of a now more efficiently run business. It is then the remaining shareholders – both voting and non-voting rights – who will benefit from the new management. From that point again there will be no difference between the value of both classes of shares.
Voting rights never matter to an ordinary shareholder except when those can be sold at a premium.
Assume this: There is a business with current market value of 10000 m. This value will change to 15000 m if it is run more efficiently. It has 250 m voting rights shares and 400 m non-voting rights shares. There is about 25% probability of change in management for better.
In this situation, corporate finance will give a control premium value for voting rights shares as follows:
Value of non-voting shares = 10000 / 650 = 15.38 per share;
Value of voting shares = 0.25 * 5000 / 250 + 15.38 = 20.38 per share
While voting rights share will have a premium, it will be difficult to calculate unless there is a high probability of change in management. A mere 25% probability will look good in theory; in practice, it will still mean a low probability of change. Only when there is a very high probability the voting rights shares should trade higher. If not, both classes should trade more or less at similar price.
When there is a very high probability of change the (maximum) value of voting rights can be in the region of (assuming business values are accurate): 5000 / 250 + 15.38 = 35.38. This appears very high compared to the non-voting shares because this example assumes far lower number of voting shares and about 50% higher new value of business.
To conclude, the investors should consider (of course among other things) only the quality of management before deciding to purchase any stock, irrespective of voting rights.
1) If voting shares of a good business (good management) are trading much higher than non-voting shares, it is far better to buy non-voting shares.
2) It does not make sense to buy any shares of a bad business (bad management) whether voting or non-voting rights.
3) A shareholder of a business with deteriorating management should estimate chances of change in management for better and if such chances are high, both voting and non-voting shareholders should do nothing.
Note that the change will happen only if some voting shareholders sell. They will need to sell (of course at a premium) to facilitate the change in management and increase the prospects of the business and its shareholders (both voting and non-voting) who did not sell.
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