Risky Business: A Review of Dual Class Share Structures in Canada and a Proposal for Reform

The publicly traded corporation has long been a source of legal debate and controversy. In the 21st century, however, a combination of highly publicized corporate scandals and financial improprieties has centered the debate surrounding publicly traded companies on the topic of corporate governance. Corporate governance refers to the framework by which business corporations are managed and controlled, and each corporation has its own unique internal characteristics and organization that impact the way it is governed. One such aspect is a corporation’s equity ownership structure that sets out the types of shares to be issued to the public, and the rights, responsibilities, and degrees of control that each share confers on its respective owner. This paper focuses on the contentious topic of dual class share structures in Canada.At their core, dual class share structures refer to a particular corporate equity structure in which different classes of common shares are issued, each with distinct voting and control rights. While organizations like the Shareholder Association for Research and Education (“SHARE”) and institutional investors like the Ontario Teacher’s Pension Plan (“OTPP”) have argued that dual class share structures reduce non-controlling shareholder wealth and ought to be banned from Canadian public stock exchanges, the evidence for this claim is less than conclusive. Others, particularly financial analysts, have argued that in some instances dual class firms have exhibited better stock market performances than even the widest held firms. This paper aims to examine both the favourable and unfavourable characteristics of dual class share structures, and argue that these equity arrangements create a precarious controlling-minority structure (“CMS”) that increases agency costs and financial risks to non-controlling shareholders. Part I of this paper provides an overview of the general structure of public corporations and how dual class firms fundamentally differ from other forms. In addition, a brief review of the history of dual class share structures in Canada is provided as well as their current relevance in Canadian capital markets. Part II examines the arguments supporting dual class firms and the potential economic benefits they can yield for society as a whole. While it is acknowledged that some examples suggest that dual class firms are an effective corporate governance structure, it is argued that these tend to be the exception rather than the rule. Part III examines, through the use of two models, how dual class share structures increase the agency costs and financial risks to non-controlling shareholders. Specifically, it is argued that as a controlling minority shareholder’s equity in the firm decreases, agency costs for non- controlling shareholders tend to rise at a rapid rate. Part IV demonstrates how these increased agency costs and financial risks occur. Particularly, it is argued that CMSs erode the traditional internal and external monitoring mechanisms that serve as effective monitoring and disciplinary mechanisms in more dispersed ownership structures. Part V considers the current regulatory regime surrounding dual class firms and argues that these limited provisions, specifically the 1987 coat-tail provision, are largely inadequate to manage the enhanced risks and agency costs that CMSs pose to non- controlling shareholders. However, rather than espousing the positions of SHARE and OTPP, Part VI of this paper proposes that the benefits of dual class firms be harnessed under a more appropriate regulatory regime that better mitigates the risks they pose to non-controlling shareholders. In particular, it is argued that the provincial implementation of a mandatory voting cap restriction is a practical step towards improving the regulation of dual class firms and minimizing the added agency costs they pose to non-controlling shareholders. Part VII concludes this argument.

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