Dual Daughters in Dual Classes

This article is part of a series on governance and references a white paper on Owner Operators that is undergoing peer review. To receive early access to that White Paper, please click here.

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The Catch-22

In the global investors’ quest to find the best assets at the best prices, one will often come across companies with a dual class shareholder structure. Many of these companies start with a visionary founder that needs to take the company public, yet wants to maintain voting control over his or her “baby.” Like any parent, this founder is rightfully placed to be the one that decides on how their baby is raised.

Founder led firms significantly outperform their benchmark, so investors are very rational to give these founders outsized control for the ability to co-invest along these founders. Data from multiple white papers shows material advantages to investing with these founders, and our white paper aspires to add to the evidence-based behavioral advantages.

Exhibit 1: Key Peer-Reviewed References on the Relationship Between Ownership and Returns

Note. Exhibit 1 includes prior work that has linked ownership with company valuation, shareholder returns, or fundamental analysis, and is ranked according to the number of citations the study has received. Effect encapsulates the impact ownership has on company performance according to the study, with “+” = favorable impact; “-“ = negative impact; “~” = neutral impact, or mixed conclusions; Citations = the number of citations the study has received, according to Google Scholar as of March 2024.

Dual Class share structures are controversial among investors and advocacy groups, but even the stiffest critics acknowledge the need and benefit to have such structures in place in founder-led businesses. Institutional investing organizations, such as CII (Council of Institutional Investors), have long campaigned for sunset clauses on Dual Classes in this case. The thinking goes that while the founder of a firm deserves to have the most influential voice on the governance of the company, their successors often have not earned that right.

It’s easy to see cases where handing over voting control to a founder or visionary manager doesn’t matter. Berkshire Hathaway, Fairfax Financial, Meta Platforms, and Google are a few firms where investors want the management to have full control.

For Meta, this was certainly not the case in 2022, when its founder-CEO was determined to build a metaverse at any expense to the shareholders. Thankfully, the CEO listened to the chorus of critics, and paired spending on his fantasy world. As he did so, earnings materially rebounded, and the critics no longer want Zuck out.

The key is, he listened to the critics. He didn’t have to. He has >60% control of the vote. But he did so, because he’s economically motivated to do so. While he “only” owns 13.6% of shares outstanding, $195 billion of his $201 billion net worth is still tied to Meta. It matters.

While not always the case, the companies that maintain a dual class stock structure often have sensitive assets that are unique and sought after. In the past, this was typically associated with media companies. Today, it’s more associated with tech companies that are investing for longer time horizons than the quarterly profit treadmill most of the S&P 500 is tethered to.

Whether or not the class of stock is inherited by heirs – often a large and complicated family or trusted non-family managers – almost doesn’t matter. What matters is that the assets are highly sought-after, and were it not for the dual class structure, they would be susceptible to takeovers or alternative management styles that these former founders, or even fellow shareholders, would likely disagree with.

This setup presents global investors with a catch-22. The assets are highly valuable, and often they are reasonably-priced, if not downright discounted — but the catch comes that they will have basically no say in the governance of the company.

For many investors, does that even matter?

These are often discounted assets, but are much higher quality than the average peer. Every single white paper on dual class companies has confirmed that dual class companies have a valuation discount versus their peers without dual classes.

Exhibit 2: Meta Analysis of Valuations of Dual Class Companies

Given that the typical company’s annual meeting proxies leave investors with zero choices – dual class or not – there are only company candidates, with no alternatives. Given most proxies give investors no ability to even vote “no,” do the votes at the average company really matter anyway?

How do investors solve the Catch-22 of being able to invest in high-quality and often heavily sought-after assets, nearly always trading at a discount to their competitors due to these governance issues?

For all of us trying to invest intelligently to create alpha, the answer to this dilemma matters deeply. To help guide our question, we can further examine academic and non-academic literature to draw some conclusions.

Examining Dual Class Performance: Ownership Matters 

Because many more firms maintain this structure far beyond the first-generation, there are more dual class companies today run by far-removed generational heirs than the founders. As prior work by Credit-Suisse showed on family-controlled companies, while the 1st and 2nd generations often maintain the best outperformance, this performance significantly declines for the third generations and beyond.

Exhibit 3: Credit Suisse Family 1000 Performance by Generation

Source: Credit-Suisse / now UBS

Interestingly, the Credit-Suisse analysis bucks the trend shown by most academic work in the past on dual class companies — that they underperform not just in valuation (as shown in exhibit 3), but that they often underperform in business fundamental performance as well. However, this is not always the case. In exhibit 4, we provide a meta-analysis of the key peer-reviewed studies on companies’ performance with dual class share structures.

Exhibit 4: Fundamental Performance of Dual Class Companies

The mixed conclusions on firm performance suggests we should look more deeply at the type of owner. Because many companies instituting a dual class structure issue equity shortly after the dual class recapitalization, with equally mixed conclusions on shareholder returns in the subsequent years – the performance of these companies often diverges from a norm.

For global investors looking for alpha and divergence, it remains a compelling hunting ground for the differentiating investor. Examining the inclusion for Credit-Suisse more closely, we understand the key reason for the divergence between Credit-Suisse’s data set and the peer reviewed literature. CS was only including family-controlled businesses where the family maintained at least 20% ownership in the underlying entity.

Our White Paper showed that the kind of ownership that decisively matters was that an insider maintains significant economic interest in the company. For companies where managers or board members maintained at least 15% or 20% of the economic interest in a company, our conclusion on the negative impact of a dual-class company changed. Even for dual-class companies, if the controlling shareholder maintains a significant economic chunk of the business, the outperformance is not as dramatic as for owner-operators, but it is far better than the dual-class peers, and the rest of the index.

Exhibit 5: Dual Class & Owner Operator Stock Performance

Note: exhibit 5 shows the relative (to the S&P 1200) performance of owner operators (where insiders own >20% of the firm), and dual class companies over a 5, 10, 15, 20 year period ending December 31, 2022.

Because only 9.5% (60 of 629) of the managers of Dual Class companies maintain a stake of >20% in the firm, we’d urge some caution behind over-extrapolating any individual data point from exhibit 5. However, the data is consistent on Dual Class companies — if paired with a significant economic stake in the business, stock returns and firm performance is better than those with dual classes and a smaller economic interest.

The Type of Owner Matters

The preliminary conclusion we can reach from examining both sets of data is that ownership matters. Period.

In fact, it matters when you have personal skin in the game. There is no substitute for personal ownership to compel the drive and humility required to build.

As our data says, the kind of owner you are greatly matters. You need your personal skin in the game – not other people’s, not another corporation’s, nor limited partners’.

Exhibit 6: Mean / Median Performance by Type of 20% Owner

Note: exhibit 6 examines shareholder returns over a 5, 10, 15, and 20-year period ending December 31, 2022, for firms based on the type of controlling shareholder that owns over 20% of the firm. For the Dual Class dataset, we removed the 20% ownership threshold, and in fact excluded those >20% insider firms.

Most surprisingly, the “professional” owners in corporations or private-equity and venture capital owners, also are unable to outperform the long-term committed owner operators that have personal skin in the game. It seems logical to conclude that when it’s someone else’s economic stake, or when it’s a consultant’s advice, it’s always sub-par to an owner’s perception of how to raise the baby they built from scratch — or sometimes, their mother or father built from scratch.

Yet, an interesting question we’ve been pondering is that although the sample set is smaller (60 firms), why are overlapping Dual Class and Owner Operators inferior in their firm performance to those without dual classes?

Again, the type of owner here matters.

Looking back at the past work from Credit Suisse, the firm showed that very significant ownership stakes (>50%) correlated to lower stock performance compared to the sweet spot of ownership of 20-50%. In fact, the segment that showed the highest long-term outperformance was the 20-30% cohort.

Exhibit 7: CS Family-1000 Performance by Ownership Stake

Source: Credit Suisse

As exhibit 7 shows, however, once the ownership surpasses 50%, the returns still show a notable outperformance but are substantially worse than the 20-30% ownership level.

This confirms prior research done by McConnell and Servaes (1990) which showed higher firm valuations achieved for the companies with a 20-50% owner (peaking around 35%) in both 1976 and 1986. Their work also showed that decades ago, owner-operated firms outperformed those with 0-10% inside ownership. But it also confirmed >40% ownership stakes result in less impressive valuations.

Why could that be?

Our theory is that 20-30% ownership (or in our work 15-20%, which had similar returns as the >20% category) does not grant the owner outright full control.

That manager must work with others and is subject to more checks and balances over their power. This theory has been confirmed by the work of Maury & Pajuste (2005) showing multiple large shareholders on the board are better than one large shareholder.

Exhibit 8: Valuation (Tobin’s Q) of Firms by # of Key Shareholders

Data Source: Maury & Pajuste (2005)

In short, unchecked leadership, while superior to the average company run by a management with little ownership, is far worse than leadership anchored by a significant amount of skin in the game — but also subject to being challenged.

Many founder biographies have emphasized how management of their companies is not democratic. However, few have been more vocal about this than notable owner operator Jeff Bezos. Multiple books on the leader have pointed towards an autocratic management style, as he frequently over-rules decisions of his managers.

How fitting, then that he’s the focus of a lot of scrutiny on one side of the political spectrum by having made the controversial decision to end Presidential endorsements at the Washington Post this year. He did this against the wishes of nearly the entire company that reported to him. Yet, Bezos owns 100% of the Washington Post. There is no alternative for the company.

A White House & Share Count Slayer

As the work of Gompers, Ishii, and Metrick (2009) showed, one of the most likely determinants that a company will have dual classes of stock is whether or not the company is in the media industry. Most of these companies retain dual class structures so as not to jeopardize editorial freedom.

These structures largely live on to this day.

Yet, as the highly divergent returns coming from these businesses show — the type of manager or owner here matters.

Sometimes you have a Buffett, or in the Washington Post’s case, a literal Warren Buffett on your board.

Katharine Graham was not just an accidental CEO of the Washington Post, but she was the first female Fortune 500 CEO.

As she describes in her own brilliant memoir Personal History, she was incredibly humble — if not downright insecure. She did not want to lead the Post. She was forced to take it in the wake of her husband’s suicide.

Yet Graham’s father Eugene Meyer always had an “intense and unwavering” relationship with her, and tried to involve her in the day-to-day business of the Post. Their mutual passion for journalism consumed much of their dialogues, going well past a typical father-daughter relationship.

She was so interested in accurate and balanced coverage of her topics of interest, that Eugene even encouraged her to take the top job at the Post.

Instead, her insecurity prevented this at first, and she ceded that job to her husband Phil when her dad took the top job at the World Bank. Phil was a very capable manager. In fact, when he took over the Post, it was a distant third in Washington D.C.-area circulation. By the time the baton was passed onto his wife following his suicide, he and his team had managed to grow the Post to being the de facto #1 newspaper of the area.

But the real magic for investors was done under the watch of his wife Katharine — the one that would take the company public just a week before the highly dramatic Pentagon Papers crisis would generate a tremendous amount of attention and volatility for the Post. Those few weeks were so dramatic and intense that Meryl Streep & Tom Hanks were compelled to star in The Post, a gripping tale of the IPO and Pentagon Papers drama. By then, Washington dominance was no longer an issue for the Post– the real race was with the New York Times.

Yet, that volatility ended up being a rounding error at the end of Graham’s career. As The Outsiders Chapter 5 details, the M&A and capital allocation-fueled adventures of Katharine and Warren produced staggering returns that out-matched the market by >17x, and her peers by >6x.

Exhibit 9: Washington Post Performance

Source: The Outsiders 

Buffett trusted Graham so emphatically that at his very first meeting with her, he offered to give her all of the voting power of Berkshire’s shares. Clearly, Graham didn’t need it, as her class A shares allowed her to appoint 7 of the 10 directors to the board.

Yet immediately establishing that level of trust between him and “Kay” ended up allowing him to have the ultimate influence on WPO’s capital allocation. And despite Meryl Streep’s and Tom Hanks’ best attempts, the real dramatic and heroic scene that played out at the Washington Post happened long after the paper successfully brought down a corrupt presidential administration.

Nearly 40% of shares were retired throughout her career, in addition to numerous accretive M&A decisions — all guided by the influence of Buffett, who never needed a vote to exercise his influence.

Katharine, who was at first insecure and filled with doubt, would gain more confidence over time. In the wake of the Pentagon Papers, she would break prior precedent and allow the Post to start endorsing Presidential candidates — with Jimmy Carter being its first in 1976. That tradition stayed with the Post until Bezos famously cancelled the endorsement process just a week ago.

Yet, even with this building courage and confidence, in her writings, she would always question whether she and the Post were doing the right things. She would focus on the quality of her work and routinely shun personal accolades. When she passed away, her eulogy headlined her characteristics of “courage, influence and humility.”

When she was asked what made a great leader, she famously would answer, “the absence of arrogance.”

By always maintaining this humble but courageous posture, she would manage to far surpass her father and husband’s “first generation” legacy and propel the company’s image and stock to unprecedented heights. Almost as if to confirm the academic and non-academic literature, she and Warren owned close to 40% of the economic interest in the company, a much closer match to the actual board control they would have.

The Other Media Daughter

 Yet, Katharine Graham had been managing the Post through a period of prolonged tailwinds for the newspaper and television industry. This more accurately mirrored the tailwinds that Meta Platforms, Google, and other technology firms enjoy today. Perhaps control is easier when the industry dynamic is easier.

These are not those times for the media industry. It’s downright cut-throat.

Shari Redstone had a relationship with her father more akin to HBO’s Succession series. She was initially dismissed by her father, yet defiantly pursued power within her family’s holding company structure to win control of Viacom and later CBS.

She is known to be a ruthlessly ambitious person, which one would think would be a great thing at this cut-throat moment for media. Yet in a Dual Class company, that also means there is zero mechanism to challenge any headstrong or over-confident chairman.

In 2019, in order to regain more control over the better-performing CBS asset, Shari chose to push for the merger of CBS and Viacom, despite a reticent board and a CBS CEO that was forcefully opposed to it. Yet, it was a way for her to re-assert control over both sides of the media house her father put together, while also bailing out the struggling Viacom.

It turned out to be a disastrous mistake, with the beginning of her term as chairwoman resulting in her first month performance immediately breaking >20% below peers. The combined company, now called Paramount Global, has been an exceptionally weak laggard in a notably tough industry. It appears the weakness from Viacom has spilled over and impacted a healthier asset in CBS. Now they are both circling the drain.

Exhibit 10: PARA Stock Performance vs. Peers

All companies, except Disney, depicted in exhibit 10 are media companies with dual-class stock structures. They are all run by the second generations of the founding family, again, except Disney.

Yet, only one has managed to deteriorate rapidly — with shareholders left with nothing to do but either run away or watch the company’s fundamentals plummet.

Exhibit 11: Media Company Fundamental Performance since Redstone’s Takeover

Shari is not a humble person. She certainly has courage, but she has far more ambition than self-doubt.

And that is exactly the point of this paper. Dual Classes sometimes really work, as in the case of Berkshire Hathaway or The Washington Post. But when they don’t work, they tend to really not work.

Shari eventually agreed to sell her controlling shares to tech billionaires Larry and David Ellison. This basically amounted to a change in control with all the innocent bystanders of class B Paramount Global — many of whom opposed the merger between struggling Viacom and healthier CBS to begin with. Turns out Shari didn’t give a crap about anyone else – just herself.

Perhaps unsurprisingly, Redstone’s National Amusements only owns less than 10% of the economic shares outstanding, versus the 80% voting power. That contrasts to Berkshire’s and the Graham Family’s near 40% economic interest in the Washington Post when Katharine Graham passed away. It confirms much prior research that the wedge between economic and voting ownership negatively correlates to firm performance.

Skin in the game matters, but more importantly, humility and a consideration of alternative viewpoints are even more important. That’s what brought Zuck from zero to hero in a mere two years. He listened. He was wrong, and he changed it.

Shari was wrong, and rather than change it, she passed the baton to another tech billionaire. Paramount shareholders are likely in no worse hands going into the Ellison’s. Yet, Larry Ellison is not known for his humility. Jeff Bezos is also not known for his humility.

Humility and courage are the two most important aspects we can learn from Katharine Graham’s example. The media world we live in today couldn’t be more different from that of the Pentagon Papers. The world needs more Katharine Grahams, and less Shari Redstones.

Less ambition, and more questioning.

Less control and more merit.

And less agents, and more owners.

And we thought that was worth sharing today.

Thank you for reading. Please let us know what you think in the comments below, or send us an email.

References

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