are tied” (Chemmanur and Paeglis 2005, p. 102). Corporations with tracking stocks report financials of the stand-alone business units for the tracking stock groups, reducing information asymmetry between insiders and the market. Although tracking stocks embody separate, tradeable assets, the parent corporation retains legal ownership and control of all assets and cash flows from which the tracking stock purportedly derives its value, suggesting that the intention to reflect subsidiary performance may not indicate economic reality. Tracking stock groups do not have a separate board of directors. Rather, the parent's board of directors sets capital allocation policies for the overall corporation in the interest of the parent, which may conflict with tracking stock group shareholders (Haas 1996).
Numerous corporate governance issues arise from the absence of legal ownership of assets. For companies with multiple tracking stocks in issue, the lack of a direct claim on assets has an interesting implication. By virtue of the parent's fundamental legal control, the value and price of one tracking stock group within a company may influence other tracking stock groups, despite theoretical independence. The returns for multiple classes of a single company's tracking stock may be interdependent, given the parent's discretion of cash flow allocation (Haas 1999).
Additionally, though the assets and liabilities are attributed to individual groups, all are ultimately owned and incurred by a consolidated entity. The obligations of any tracking stock group are thus shared by each of the other groups (Haas 1996). Although the earnings attributable to the tracking stock group should determine the dividends available to the group, the board of directors sets dividend policy and may determine to divert funds away from the profitable group toward less profitable groups in the best interest of the corporation as a whole (Logue, Seward, and Walsh 1996).
In relation to traditional stocks and bonds, tracking stocks are a relatively new development, first designed in 1984. Murphy (1989) offers a comprehensive analysis of General Motors Company's (GM) inaugural offering. This offering sought to provide investors with choice, aligned managerial incentives, and information via the separately traded security, while GM retained legal ownership of a newly acquired subsidiary's assets, and GM's board of directors made capital allocation decisions. The issuance of tracking stock is a form of corporate restructuring like a spin-off or equity carve-out in which shareholders in a tracking stock group do not have a legal claim on the underlying subsidiary assets it tracks (Danielova 2008). Tracking stocks also provide investors with an increased choice: Rather than investing in the conglomerate, investors may choose to invest in a corporation's tracking stock for a specific subsidiary, often faster-growing than the parent organization (Murphy 1989). Given that diversified firms tend to carry a discount to their theoretical value, tracking stocks are a corporate restructuring tool that attempts to unlock value by creating a pseudo pure-play company, without relinquishing control (Billett and Mauer 2000). Because of separate financial reporting for tracking stock groups, management may be compelled to improve operating decisions for the division more than would otherwise occur (Harper and Madura 2002).
DUAL-CLASS COMMON EQUITY
Dual-class structures separate economic ownership from control via the difference in voting rights for each share class. This wedge between the degree of economic interest and actual voting power to affect corporate changes has been subject to investor debate. Economic ownership and voting power are intrinsically linked for a single class of equity: one share equals one vote. However, dual-class equity structures give preferential voting rights to one class of stock. Holders of these super-voting classes then retain outsized influence per unit of economic ownership. With a dual-class structure, influence and control instead become independent from an economic interest in the company.
In a dual-class structure, the firm ascribes superior voting rights to one class and inferior voting rights to another. Generally, the share classes have equal rights in all other aspects, such as liquidation. Some corporations may offer other tangible benefits to holders of inferior voting shares, such as preferential dividends rights or the right to vote as a class to nominate a certain number of directors. Burkart and Lee (2008) present a comprehensive survey analyzing the impacts of deviations from the one-share-equals-one-vote structure.
In the past decade through 2019, the increase in the incidence of dual-class structures fueled immense criticism because such structures intrinsically violate one-share-equals-one-vote, disenfranchising certain shareholders. Over this period, several technology companies, such as Facebook, Snap Inc., Uber, and Lyft, in their initial public offerings (IPOs) raised equity capital in the public markets while concentrating control of the corporation with founders and other insiders. Although recent furor and press coverage generally discuss the use of dual-class stock by technology and media companies, the Council of Institutional Investors (CII), an influential association of investment firms focused on corporate governance, maintains a comprehensive list of over 250 U.S. incorporated companies with disparate voting rights (Council of Institutional Investors 2019). In 2018, the CII petitioned the NYSE and NASDAQ to prevent companies seeking new listings from going public with dual-class shares (Williams, Mahoney, and Bertsch 2018a, 2018b). Advocates against dual-class shares decry super-voting structures as anathema to shareholder democracy, the one-share-equals-one-vote principle recommending that influence and control be proportionate to economic interest. This shareholder structure has seen renewed interest to be more common as many closely held, founder-led technology companies seek to retain control while also raising equity capital in the public markets (Condon 2018).
Without an outright prohibition of dual-class shares, several opponents of dual-class stock suggest sunset clauses as potential remedies in cases of perpetual dual-class stock. Bebchuk and Kastiel (2017) agree that dual-class stock may be efficient for companies going public, but believe that efficiency declines over time, and therefore that sunset clauses empower shareholders to revisit and eliminate, if necessary, the dual-class structure. In response to the CII's petitions, Berger (2019) contends that does not only empirical evidence fail to support compulsory sunset provisions, but also, without dual-class stock, ownership of common stock for many companies has become concentrated in a few large institutional investors. Moreover, according to Burkart and Lee (2008), linking economic ownership with control is not optimal for widely held firms. Proponents of dual-class stock point to several economic benefits provided by this ownership structure. Dual-class shares permit management to focus on long-term value creation without preoccupation with short-term profits or demands of activist investors (Govindarajan and Srivastava 2018). For young founder-led dual-class firms, the economic wealth and reputation of the founders is highly correlated with the firm's value and performance, aligning incentives with inferior voting shareholders (Kim and Michaely 2019).
Discovery Inc.: A Case Study
Discovery, Inc. is a global media company incorporated in the United States whose share capital is divided into three series of common stock – Series A, B, and C – and two series of convertible preferred stock – Series A-1 and C-1. With Discovery's three classes of common stock, the economic interest varies substantially from the respective voting interest of the class. Discovery's Form 10-K filing with the SEC indicates that these three classes “have equal rights, powers and privileges, except as otherwise noted” (Discovery, Inc. 2019, p. 120), continuing to explain that the only material difference between the share classes is voting power attributed to each series of stock. Besides the three series of common stock, Discovery's share capital also includes two series of convertible preferred stock, Series A-1 and Series C-1, which are convertible into Series A and Series C common shares, respectively. Table 2.1 presents Discovery, Inc.'s common share structure, exemplifying the wedge between economic and voting interests among the share classes.
TABLE 2.1 Discovery, Inc. Common Equity Share Class Structure
Source: FactSet (2019).
| Class |
Ticker
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