The Social Costs (and Benefits) of Dual-Class Stock

Dual-class stock structures allow founders to sell equity in their company without giving up control. These devices accomplish this by creating one class of stock with extra voting rights for founders and another with lesser voting rights for the general public—or no votes at all. They enable a giant company to be legally controlled by just two people (in the case of Google, for example) or even a single man (e.g., Facebook). More and more technology companies have selected these structures at the initial public offering stage, including Palantir, Snapchat, Lyft, Airbnb, and Dropbox (as well as Google and Facebook), and in 2020 they accounted for a majority of the IPO market by value.

Dual-class stock has attracted considerable academic attention for its potential to insulate the founder’s idiosyncratic vision from market pressures—for good and for ill. However, the focus of these agency costs critiques is on the dual-class structure’s effects inside the firm. In a forthcoming article, I argue that important social implications of dual-class stock overflow the boundaries of the firm—in brief, that the structure generates the potential for significant benefits and costs for society. The article advocates for changes to SEC regulations to help mitigate the social costs and increase the social potential of dual-class stock.

Social Costs and Benefits

The social benefit of dual-class stock flows from the structure’s claimed potential to increase scale: in the long run, it is hoped that many of the fruits of increased innovation and productivity will not remain exclusively in the firm’s hands but will spread to other firms and society at large.

On the other hand, dual-class stock structures also create two distinctive categories of social cost. The first comprises acts that have an insufficient nexus to the core purpose of dual-class stock (dual-class “frolics”), i.e., acts that depart from the founder’s scale-enhancing vision—for example, efforts to exempt the firm from generally applicable regulations in a way that earns it no competitive advantage. The second is dual-class “exploits,” which are acts that exploit the scale advantages of the dual-class structure for purposes that serve shareholders but frustrate public policy.

Dual-class frolics and exploits both illustrate the limitations of defining the costs of dual-class stock in agency terms. Outside the narrow doctrine of corporate waste, frolics are not conceptualized as “costs” for corporate law purposes at all; they would just be unsound business judgments. Exploits may pose a more vexing problem. There is no shareholder mechanism to check a founder who is pursuing corporate interests too strongly—and it is unrealistic to expect corporate law to afford one.

Frolics and exploits by dual-class founders raise unique concerns for the simple reason that they substitute the corporation for the individual, allowing a single person to marshal the full force of corporate law—and, to a degree, constitutional law—in promotion of her personal vision with only a tenuous connection to corporate purpose. Whatever the benefits of that model for shareholders in specific cases, the risks it creates for society are distinct—and are not likely to be redressed by measures designed to help shareholders qua shareholders. Recent caselaw raises the stakes of these risks.

By way of example, suppose a dual-class company defies a generally applicable regulation, for example a mandate to offer insurance coverage for contraception (the issue in Hobby Lobby v. Burwell), on the grounds that compliance would violate its sincerely held religious beliefs. Whose beliefs? a court would ask. The firm would respond: those who have a voice in the corporation’s affairs. Suppose further that the corporation’s founders own only a small share of its equity but control 99 percent of the votes, like the founders of Snapchat. It is unsettled how courts would treat a Hobby Lobby-type claim if acted upon sincerely by dual-class founders in this position.

In the case of dual-class exploits, one could easily imagine a large dual-class firm leveraging its scale to engage in donations or other acts (under Citizens United v. FEC) intended to influence the political process. Whatever one’s view of the wisdom of that decision, dual-class exploits would seem to raise distinct issues if one takes dual-class firms’ claims to greater scale advantages seriously.

How to Curb Dual-Class’ Social Costs

Two reforms, if adopted by the SEC, would help bend the balance of dual-class stock’s social costs in a favorable direction.

To address dual-class frolics, the SEC should make it easier to bring shareholder proposals at dual-class firms under Rule 14a-8. Firms with unequal voting rights should have a harder time excluding shareholder proposals, which are precatory anyway.

Exploits—acts that seek to inappropriately cement the dual-class founder’s scale-enhancing vision—present a challenge of a different character. This agency gap is a key reason to consider the social costs of dual-class stock to begin with. It arguably serves shareholders but frustrates the public interest—for example, by facilitating large corporate campaign contributions with the aim of forestalling platform regulation.

To address dual-class exploits, dual-class firms that engage in political spending should be barred from government contracts for a period of two years afterwards. The SEC has already adopted the same restriction for a different type of regulated entity, investment advisers; this proposal would extend it to dual-class firms, and for the same reason: to curb inappropriate influence of public officials (or the appearance thereof). Under Citizens United, stricter limitations on political spending might face a dubious constitutional fate; the SEC’s restriction on political contributions by investment advisers, however, has survived challenge under both the Administrative Procedure Act and the First Amendment.

These reforms would help mitigate the distinctive externalities of dual-class stock while at the same time preserving its special potential for powering innovation and economies of scale. That balance of priorities, and the mechanisms it harnesses, can inform approaches to externalities of the firm more broadly.

The complete paper is here for download.