This week, Alibaba Group Holding Ltd. tapped New York for what may be the largest initial public offering of a Chinese technology company. The New York Stock Exchange or Nadaq would be a logical choice because, unlike the Hong Kong exchange, neither enforces a “one share, one vote” rule and allows the issuance of stock with different voting rights.
Alibaba, which is valued at as much as $200 billion, should beware: giving one set of shareholders disproportionate or exclusive voting rights may sound like a great idea. But the practice's history in the U.S. shows that not all companies that embrace dual shares live happily ever after.
In the early 19th century, different classes of shareholders in U.S. public corporations had different voting rights. But corporations didn’t disenfranchise ordinary investors; they limited the voting rights of large stakeholders.
Some corporations gave every shareholder a single vote, regardless of the size of their stake. Most often, however, corporations simply capped the number of votes any single investor could cast, or instituted the stockholder equivalent of progressive taxation, as historian Colleen Dunlavy has observed.
For example, a shareholder who owned 50 shares would get 50 votes. But for any stake above 50 shares, one additional vote was awarded for every two shares. That meant each additional share paid diminishing returns when it came time to vote.
Over the course of the 19th century, this quaint system gave way to the modern idea that each share translates to one vote. But one share, no vote? Not a chance. In general, owners of any class of shares -- common, preferred -- had comparable voting rights.
Around 1900, however, a few corporations issued stock that conferred different voting rights on different blocks of stock. The pioneers were tobacco companies such as R.J. Reynolds, but also the International Silver Company; the Federal Mining and Smelting Company; Royal Baking Powder; and American Caramel, which almost had a monopoly on, well, caramels.
Few of these corporations simply divided stocks into voting and nonvoting shares. Rather, they limited the voting rights of certain classes of shares, or gave a single class of investors the right to elect a majority of the board of directors. Other companies limited voting rights pending some financial milestone: the payment of dividends, for example, or emergence from bankruptcy.
Such distinctions insured that a handful of investors could control a corporation. For example, in 1904, the New York, Ontario & Western Railroad had more than $58 million in outstanding stock, only $4,000 of which was preferred. But it was the owners of the preferred stock who got to elect a majority of the board of directors.
Such arrangements didn’t sit well with everyone. The Wall Street Journal lamented that when it came to control of corporations "the tendency seems to in the direction of autocratic rule, and away from democracy.” Such “evils,” the paper concluded, could only be solved by the creation of a national incorporation law that preserved the “one share, one vote” principle.
By the 1920s, the practice of depriving one class of shareholders of voting rights was commonplace. And things might have continued this way but for a Harvard University economics professor named William Zebina Ripley.
The catalyst was the listing of two corporations on the Big Board in 1925: Dodge Brothers Inc. and the Industrial Rayon Corporation. Both vested exclusive voting power in the hands of a small class of shareholders. Ripley said this "plague" amounted to the “rape” of ordinary shareholders’ “voting power.” But he was no radical, as historian Julia Ott has noted. Rather, he feared that these abuses would kill the public’s faith in the stock market.
Ripley’s essays, which were published first in the Atlantic before appearing as a book, whipped public sentiment against Wall Street. The professor was feted on the front page of the New York Times, and President Calvin Coolidge invited him to the White House. The Department of Justice announced it was looking into the matter of multiple levels of voting rights.
The writing was on the wall, and in 1926 the NYSE announced that it would “give careful thought to the matter of voting control.” That spring, the push for reform gathered momentum when the Interstate Commerce Commission stopped the consolidation of some railroad companies on the grounds that “the entire body of the stockholders of a railroad … and not a powerful few, should be responsible for management.”
The stock market scandals of the Great Depression only heightened skepticism toward Wall Street, and soon the idea of “one share, one vote” acquired the status of holy writ. The practice was banned, and in the 1940s, the NYSE released a statement that celebrated its commitment to “corporate democracy,” though it would occasionally bend the rules.
By the 1980s, however, pressure began building on the NYSE to reconsider its ban. The American Stock Exchange and Nasdaq had no commitment to one-share, one-vote stock offerings, and growing numbers of blue-chip companies began embracing dual-class shares. In 1986, the NYSE permitted the first such listings, though they remained the exception rather than the rule.
But the NYSE’s move met with widespread criticism, and the Securities and Exchange Commission ultimately responded with a plan to keep companies from issuing securities that resulted in “nullifying, or restricting, or disparately reducing the voting rights of holders of such issuers’ existing common stock.”
This eventually became the short-lived Rule 19c-4, which was struck down by the D.C. Circuit Court in 1990. Nonetheless, 19c-4 has lived on in other guises, most notably after SEC officials persuaded the major exchanges to “voluntarily” adopt policies that restrict the issuance of non-voting common shares. While there are exceptions, such as Google Inc., the idea of “shareholder democracy” continues to exercise a remarkable hold on the nation’s investing psyche.
Alibaba’s founders might want to keep this history in mind. A company that seeks to restrict the voting rights of its shareholders may ultimately discover that the American notion of “one share, one vote” is alive and well.
(Stephen Mihm, an associate professor of history at the University of Georgia, is a contributor to the Ticker. Follow him on Twitter at @smihm.)
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