German index provider Solactive has written a research note, ‘The Dilemma of Multiple Share Classes’, partly in response to a recent newspaper piece which described the multiple share class structure as challenging to corporate standards as one share doesn’t necessarily equal one vote anymore.
Solactive writes that satisfying shareholders by focusing on quarterly earnings forecasts and therefore adopting short-termism over valuing long-term performance was debated by Warren Buffett, as well as Jamie Dimon. A factor potentially contributing to companies’ long-term performance is the share class structure.
Timo Pfeiffer (pictured), Head of Research at Solactive, says: “As multiple share classes have recently attracted more media attention, we, as the research team, have thought it would be a great opportunity to dig deeper into the topic and see how much long-term performances are truly affected by the difference of issuing share classes, and therefore either distributing voting power, or leaving it within the company.”
In the research blog post ‘The Dilemma of Multiple Share Classes’, Solactive has been investigating the relationship between the issuance of multiple share classes and a company’s long-term performance by constructing a portfolio composed of companies weighted by market capitalisation with multiple share classes offering different voting rights in the US.
The firm writes that it is interesting to look at numbers in order to understand the impact of voting rights on the historical performance of share prices. To compare apple to apple, as the firm puts it, Solactive constructed a portfolio composed of companies weighted by market capitalisation with multiple share classes offering different voting rights in the US. The resulting index is benchmarked against the Solactive US Broad Market Index.
As a first observation, over a window of 14 years historical performance, the portfolio of stocks with multiple share classes outperforms in terms of returns, however, its volatility is slightly higher.
The returns of the two respective indices are 11.0 per cent and 8.9 per cent, and the corresponding Sharpe ratios are 0.56 and 0.49. Remarkably, from the constituents of the starting universe, only 48 companies had multiple share classes in 2004. This number increased by more than 300 per cent in the last few years, reaching 155 companies at the end of 2017.
“And NO, contrary to the common belief, these companies are not exclusively in the technology sector, the Consumer Services and the Finance sectors have important allocations in such an index. The allocation to the Technology sector has been increasing with the increasing size of the constituent companies.
“A closer look at the composition shows the following: first, the top five companies had individually outperformed the market by a factor of two.
“Second, the leading company is Mastercard, and interestingly Alphabet ranks only in the fifth position. Third, 61 companies out of 155 outperform the broader benchmark index.”
Solactive concludes that the numbers suggest that securities with multiple share classes tend to behave better over time than single share class securities.
“Additionally, the market has seen securities with single share class compensating the investors on the short-term, but risking the company on the long-term. A relevant example is Seadrill, a drilling contractor that recently filed for bankruptcy as the company badly managed the cash reserves prior to the oil’s price crash. On the other hand, Alphabet, a company with multiple share classes, halted a project with the Pentagon after pressure was put on the management internally by the employees and other internal stakeholders.”
Solactive concludes that the markets are not black and white, the debate will continue, and so will the opportunities for outperformance.