Class 8

Financing the Corporation – Shares

 Financing the corporation
Two basic forms:
1) Equity: shares
2) Debt: Bonds and debentures
 What are the differences?
Shares
- Residual claimants of the corporation
- Risk losing their investment and not obtaining any
dividend (but..?)
- Have more administrative rights
Bondholders
- A contractual right to receive interest and the principal
- Limited administrative rights, but can use contractual
power to influence the conduct of the corporation
 Basic Features
Economic rights
– Generally, no right to dividends; distribution can
be decided by BOD or SHS (issue: possible abuse
in not distributing dividends)
– Possible repayment of principal in case of
liquidation, and of a surplus, but only if something
is left after the creditors have been paid
(shareholders are the “residul claimants”)
 Administrative Rights
- Voting:
• Election and removal of board members
• Amendemenets of governing documents of the corporations
• Particular financial transactions like mergers
- Information rights:
- Challenge the shareholders’ meeting
Does it sound like they own the company?
Note that in U.S. and in other common law jurisdictions
shareholders have way less power than in Italy. So do not focus
too much on what you studied in Italian corporate law class (if you
took one). Shareholders powers aren’t the same everywhere.
 Mixed economic-administrative
- Pre-emptive rights, mandatory in some
jurisdictions (e.g., EU and UK), optional in others
(e.g., US)
- Appraisal rights for dissenting shareholders

We will get back to this…

 Classes of Shares
• Common, or ordinary shares (your “plain vanilla”
shares)
• Preferred shares
Generally, have more economic rights than common
shares, but also less administrative rights
• Limited voting shares
• Multiple voting shares
 Class Voting
• Corporation issues 50 common shares (CS)
and 50 limited voting preferred shares (PS)
- A has 80 CS and 10 PS
- B has 20 CS and 40 PS
Assume that they have to vote on a merger. If CS
and PS vote together, A decides. If they vote
separately, B can veto the transaction.
 Dual Class Shares
• What are they?
- The general rule is that each share has one vote, but
corporations can deviate by issuing shares with
differential voting rights
- The companies that issue shares of various kinds are
generally called “dual class” companies
 Question of the day
Should dual class shares be allowed?
Group 1:
Group 2:
 Why does it matter?
• Dual class companies have an aggregate
market capitalization exceeding $3 trillion
• The number of companies with dual class
shares is growing
• Companies that went public with dual class
shares include Berkshire Hathaway, Google,
Facebook, News Corp., Nike, Snap, etc
 Dual class shares
Which agency problems?
- Shareholders v. manager
- Majority v. minority shareholders (careful
here!)
 Cons of dual class shares
• Insulate management from market pressure leading to
entrenchment. Entrenchment insulates the management from
the disciplinary force of the market for corporate control.
• Exacerbate the agency problem between shareholders and
managers
• “[t]he Investor Stewardship Group-a collective of some of the
largest U.S. institutional investors, including Vanguard, BlackRock,
State Street, and T. Rowe Price has likewise taken a position
against dual-class companies in its Framework for U.S.
Stewardship and Governance.” The Framework included as a
fundamental principle that “[s]hareholders should be entitled to
voting rights in proportion to their economic interest.” (why?)
 Separation of Cash Flow and Control

- Usually both administrative and economic rights are

proportional to the stake in the company, but dual class
shares break this relationship
- Dual class shares break this relationship and might lead to
distorted choices.

“Such distorted choices may include the appointment or retention of the controller or
a family member as an executive rather than a better outside candidate, engagement
in inefficient self-dealing transactions with an entity that is affiliated with the
controller, the usurpation of an opportunity that would be more valuable in the hands
of the company rather than the controller, or other choices aimed at increasing private
benefits of control at the expense of the value received by other shareholders.”
(Bebchuk & Kastiel)
 Imagine this scenario
- I own 10% of the shares in company A, but I
control the company thanks to multiple voting
shares
- I also own 100% of the shares in company B

Can I profit from selling A assets to B for a very low

price?
Can I profit from buying B assets with B for a very
high price?
 Why?
Why do investors buy shares of firms with dual
class shares?
Why should we allow dual class shares?

• dual class shares allow managers to focus on

long term goals, and grant innovative
founders the freedom to pursue their vision
• Private ordering
Can you see Pangloss?
 Article 2351 Italian Civil Code
Voting Rights
1. Each share grants the right to vote.
2. With the exception of provisions in separate statutes, the bylaws can
allow the issuance of shares without voting rights, with voting rights
limited to specific decisions, with voting rights conditioned upon specific
events not merely depending on the will of a party. The amount of limited
voting shares cannot exceed half of the capital.
3. The bylaws can provide for limitations to the voting rights of a single
shareholder independently from the amount of shares owned, or scaling
voting rights.
4. In the absence of special provisions, the bylaws can allow the issuance
of multiple-voting shares also with respect to specific decisions or
conditioned upon specific events not merely depending on the will of a
party. Each multiple-voting share can attribute a maximum of three votes.
 Common and Limited
Voting Shares in the U.S.
DGCL § 212. Voting rights of stockholders; proxies; limitations.
(a) Unless otherwise provided in the certificate of incorporation and subject to § 213 of this
title, each stockholder shall be entitled to 1 vote for each share of capital stock held by such
stockholder. If the certificate of incorporation provides for more or less than 1 vote for any
share, on any matter, every reference in this chapter to a majority or other proportion of
stock, voting stock or shares shall refer to such majority or other proportion of the votes of
such stock, voting stock or shares.

NYBCL § 501. Authorized shares.

(a) Every corporation shall have power to create and issue the number of shares stated in its
certificate of incorporation. Such shares may be all of one class or may be divided into two or
more classes. Each class shall consist of either shares with par value or shares without par
value, having such designation and such relative voting, dividend, liquidation and other
rights, preferences and limitations, consistent with this chapter, as shall be stated in the
certificate of incorporation. The certificate of incorporation may deny, limit or otherwise
define the voting rights and may limit or otherwise define the dividend or liquidation rights
of shares of any class, but no such denial, limitation or definition of voting rights shall be
effective unless at the time one or more classes of outstanding shares or bonds, singly or in
the aggregate, are entitled to full voting rights, and no such limitation or definition of
dividend or liquidation rights shall be effective unless at the time one or more classes of
outstanding shares, singly or in the aggregate, are entitled to unlimited dividend and
liquidation rights.
 Tenure voting
• Can it be alternative to dual class shares?
Tenure voting increases the voting power of long-term shareholders in order
to incentivize them to become long-term investors and is adopted by
companies to mitigate perceived short-termism.

key idea behind tenure voting: rewarding shareholders who have a special
interest in the performance of the company by granting them extra voting
power.

But who are the long-term shareholders of today?

 Issuing new shares
• Who decides?
United States
- This power is generally with directors
- limitation: they can only issue the number of shares
authorized by the article of incorporation, but usually the
article of incorporation authorizes a number of shares
much larger than the number of outstanding shares
Europe
- Any capital increase must be decided by the general
shareholders’ meeting
 Pre-emptive Rights
• Definition
Pre-emptive rights give the right to shareholders to buy
newly issued shares before the general public
• Why are they needed?
- dilution of voting power
- If the shares are sold on the market at a low price, it will
reduce the value of the investment of existing
shareholders
- Why not?
- Greater flexibility to raise capital
 Pre-emptive Rights
Mandatory in some jurisdictions like U.K. And
the European Union.

In U.S. pre-emptive rights are not available,

unless the governing documents grant them to
the shareholders.
 Pre-emptive Rights
• EU Legislation
• The Italian system: stronger protection for the interest of the shs than for the
interest of the corporation to maintain a flexible financial financial structure
– The issuing of new shares as an amenedment of the charter: shs approval
(extraordinary shs meeting), but it can be delegated to directors
– Existing shareholders have mandatory preemptive rights to purchase the new share
proportionally to their stake in the corporation
• Limitations to Preemptive Rights
– Contribution in kind (specific business purpose needed)
– Where the interest of the corporation requires it (e.g. when a corporation is going
public)
– Shares to be offered to the employees of the corporation
– In listed corporations: up to 10% of the pre-existent capital if the charter so provides
• Issuing price of the new shares in case of limitation or exclusion of the preempitve
rights