The Dual-Class Stock Revolution

We examine one of the most significant developments in U.S. capital markets: the rise of dual-class share (DCS) structures in initial public offerings. In the mid-1990s, only a small fraction of IPOs used dual-class; in recent years the figure has hovered around a quarter to a third of new listings. While the costs and benefits of dual-class have been heavily debated, far less attention has been paid to a prior question: why has this structure become so prevalent, and why now?

The leading recent explanation, associated with Dhruv Aggarwal and co-authors, focuses on founder bargaining power. Abundant private capital and lower capital requirements allow founders to delay going public and to insist on control-enhancing mechanisms, such as dual-class, as a condition for listing.

We argue that this explanation is only part of the picture. Even if founders can demand more, it is not obvious why they choose to “spend” their bargaining power on voting rights rather than on additional cash-flow rights. A larger equity stake for founders without a wedge between control and ownership would fortify incentives while limiting entrenchment. The founder-bargaining power account does not explain why such elevated bargaining power buys control rather than cash.

Our alternative explanation situates the rise of dual-class in the broader evolution of U.S. corporate governance over the past four decades. We highlight two developments. First, traditional anti-takeover defenses—poison pills and staggered boards—have sharply declined among seasoned firms, making control much more contestable. Second, the main threat facing incumbents has shifted from hostile tender offers to activist hedge funds running proxy contests. Both developments, we argue, are driven by a common structural force: the concentration of share ownership in the hands of large institutional investors.

The story begins with the takeover wave of the 1980s, when raiders forced boards to confront the risk of losing control. Lawyers responded by engineering poison pills and staggered boards, which, once upheld under Delaware law, spread widely and gave incumbents meaningful leverage against unsolicited bids.

Since the early 2000s, however, these defenses have come under sustained pressure from institutional investors and their proxy advisors. Pills that remain in place for extended periods, or staggered boards, are now routinely opposed and can trigger significant reputational costs for directors. Seasoned corporation therefore often de-classify their boards, and while directors remain formally free to use pills, they are reluctant in practice to do so except in narrow, time-limited circumstances.

For a founder contemplating an IPO, this shift is critical. Pill and board defenses are now fragile and reversible: while they can be initially adopted, they can be removed by a later, more investor-responsive board, and their continued use can provoke investor backlash. Dual-class structures, by contrast, are embedded in the charter at the IPO stage and cannot be dismantled without the controller’s consent. They offer a move from “partial protection” to near-complete insulation from control challenges. As traditional defenses fade, founders therefore have strong reasons to rely on dual-class as the main tool to secure long-term control.

At the same time, the nature of the common control threats has changed. In the past, when the classic threat was a hostile tender offer aimed to acquire the target, pills and staggered boards were powerful protections for the target board. Today, the dominant threat is activist hedge funds that buy relatively small stakes and seek board representation and strategic changes, not full control. Standard poison pills do little to deter such campaigns, and staggered boards can slow, but not block, the election of activist nominees, who can exert significant influence even with minority seats. More so, specially designed anti-activist poison pills face hostility from the courts, and therefore cannot be trusted by incumbents either.

Against such activism, however, dual-class stock is uniquely potent. By concentrating voting rights in insiders’ hands, it deprives activists of their most effective weapon: the credible threat to reconfigure the board by winning a shareholder vote. Altogether, we document an inverse relationship between the decline of pills and staggered boards in the S&P 500 and the rise of dual-class IPOs over time, consistent with dual-class functionally replacing traditional defenses as the preferred control device.

The next step in our argument is to identify the common catalyst behind both the decline of traditional defenses and the rise of activism: the dramatic and increasing dominance of institutional investors. Large index and mutual fund families now hold a dominant share of U.S. equities, and a small number of “universal owners” control a pivotal share of the votes in most major companies. Their business model and fee structure give them weak incentives to engage in intensive firm-specific monitoring. Instead, they tend to focus on highly salient, easily communicable governance issues—such as de-staggering boards, limiting poison pills, and occasionally backing activist campaigns—that play well with clients and may increase funds inflow.

This helps explain the apparent “split personality” in institutional investor behavior. In public governance debates, institutional investors oppose both traditional takeover defenses and dual-class structures. Their concentrated voting power has been decisive in dismantling pills and staggered boards and in enabling activist campaigns. Yet at the IPO stage—a far less transparent process in which institutional investors’ role in bookbuilding and allocation is largely below the radar —they are much more accommodating of dual-class structures.

We point out two mechanisms for this accommodation. First, index funds are often not yet invested at the IPO stage, and therefore to not directly take part in the negotiations over governance terms. Second, there is evidence that dual-class IPOs tend to be more heavily underpriced than single-class offerings. Large institutions that receive favored allocations in underpriced IPOs can capture substantial first-day trading gains. From their perspective, this underpricing premium may offset abstract governance concerns about dual-class.

Finally, we contend that the normative implications and policy recommendations arising from these developments should focus on expanding the set of viable and durable governance mechanisms available to founders at the IPO stage. In the prevailing corporate governance environment, dual-class share structures have effectively become founders’ only sustained control-protection option, as traditional forms of partial protection have become all but meaningless.

Legislative or judicial doctrinal clarification expressly permitting IPO-chartered anti-activist pills – or even more robust IPO-chartered slow-hand pills – could therefore furnish boards with durable forms of partial protection against activist campaigns. By providing boards with such arrangements at the IPO stage, such reforms could meaningfully reduce founders’ reliance on dual-class shares and correspondingly diminish their prominence in contemporary corporate governance.