There are currently 505 common stocks in the S&P 500. Some people think it’s because certain stocks are in the process of being listed or de-listed, but one of the causes is different share classes. Why would a company want to offer different share classes and what does that mean for the owners of those shares? Today we’ll talk more about that because it affects you if you own shares in a company, are starting your own company, or are being offered shares as compensation to work for a start-up.
First things first, what are the different share classes? A company can offer different classes of shares to different people within their company. Share classes DO NOT refer to preferred stock compared to common equity; those are two entirely different kinds of securities. A share or stock class refers to Class A, B, C, or any letter, of different shares that companies offers. They are generally manifested as Class A and Class B shares. These shares usually carry different voting rights for their owners and that difference is usually about 10 times greater or fewer votes per share. Companies will sometimes change which shares have more voting power, so it’s important to do research into which specific class of shares has the voting rights, because it’s not always Class A as some assume.
Most of the time all shares will carry the same rights to profit, called economic value. This is important because companies cannot change their return on equity, meaning that they cannot make different share classes result in a different ROE. So, what does this mean for different owners? Well, in some cases, different share classes can be a problem for typical investors because shareholders could believe that the owners of the powerful voting shares are poor managers. This is a problem because while the decision makers of the company could hold a small percentage of the actual shares, those same decision makers could hold most of the voting rights of the company.
For instance, take Google in 2014. They issued a special kind of stock split where they would take their publicly traded Google shares and split them into three different kinds of shares. They were going to give out Class A, B, and C shares to different kinds of investors. Anyone who had a Google share before the split was given an equal number of Class A shares. Class A shares only had one vote per share, but Class B shares had 10 votes per share. Class C shares were going to be publicly traded as well, but had no votes. Guess who got the powerful Class B 10x voting shares? You guessed it. Company insiders and executives.
This was done so that the founders of Google and the chairman of the board could cash out their shares (the Class A shares) while still retaining their control of the company (the Class B shares). At one point, managers of the company owned only 16% of the total number of shares in the market, but they controlled 61% of the voting rights. How’s that for a palindrome?
So how are prices for these shares determined? A company will decide to issue two different share classes for whatever reason they have. They will hire an equity analyst and find a similar company with different share classes and use the premium of the voting shares over the non-voting shares as their own differential. They will then take this premium and add it to their voting shares and take it away from their non-voting shares. After they release these shares into the market, the market prices them as it sees fit. Companies will often do this is they want to give shares to friends of family so that they can create a market for their equity and let others get in on the action.
Therefore, the S&P 500 contains more than 500 shares. When a company splits stock into different classes, it technically creates two different securities which control the same company (the same way bonds and stock control the same company, but in different economic ways). Since the S&P 500 must now own both securities to represent what the market looks like, the index must now own two shares that represent one company, or 505 shares that represent 500 companies.
Companies can do this to attract certain kinds of investors, or companies may do this to let certain founders leave the company while getting paid for it. There is a special type of share called a redeemable share class that can be offered, which is a share that the company issues that carries the right for the company to buy the share back later. These kinds of shares are often given to employees, and in case the employee finds other employment, the company can buy the share back. More of an interesting topic to understand than an essential investing topic, but this will give you just one more thing to talk about in an interview or chat with your advisor about! Happy investing!
Sources:
Company Law Club. (2017). Classes of Shares. Retrieved from Company Law Club: http://www.companylawclub.co.uk/classes-of-shares
Investopedia Staff. (2017). Why would a company have multiple share classes, and what are super voting shares? Retrieved from Investopedia : http://www.investopedia.com/ask/answers/05/070405.asp
Norris, F. (2014, April 2). The Many Classes of Google Stock. Retrieved from The New York Times: https://economix.blogs.nytimes.com/2014/04/02/the-many-classes-of-google-stock/?_r=0
Rogers, K. (2017). How to Allocate Equity Value Between Different CLasses of Common Stock. Retrieved from Chron : http://smallbusiness.chron.com/allocate-equity-value-between-different-classes-common-stock-81267.html