The rise of founder rule

Seventy years ago, the New York Stock Exchange granted what was then a special exemption to its 1926 policy barring the sale of nonvoting shares in a public company to Ford Motor Company, allowing it to have an IPO due to its prominence and success.

The dual-class structure, which grants voting control to a company run by a family or small group of company executives, had been used before the 1920s and would become more common in the 1960s, especially by media companies - which often were controlled by a single family.

Space Exploration Technologies Corp., whose shares soared 19% in its trading debut Friday, followed Ford's path, using a mechanism has become popular among founder-controlled technology companies such as Alphabet Inc., which went public as Google in 2004, and Meta Platforms Inc., which went public as Facebook in 2012.

Dual-class IPO structures often give founders 10 votes per share, as was the case with Google founders Larry Page and Sergey Brin, which has given them majority voting control. Meta Platforms CEO Mark Zuckerberg controls 61% of the company's voting shares.

Elon Musk controls 85% of the voting power at SpaceX, and the company - incorporated under Texas law - has included a provision allowed under state statute requiring any shareholder lawsuits to be subject to mandatory arbitration.

That's an effort by the founder to avoid the shareholder litigation he frequently was targeted with at Tesla Inc., his other public company that was first incorporated in Delaware before moving to Texas.

Jay R. Ritter, an emeritus professor at the Warrington School of Business at the University of Florida, said dual-class structures - once a rarity in the early 1980s and still uncommon as late as 2014 - accounted for nearly half of all technology IPOs last year and more than 41% of public offerings overall.

Investors have become more willing to invest in such companies despite having limited voting rights.

"If there hadn't been a bunch of successful, dual-class tech IPOs like Google and Facebook, it would be a lot harder for companies today to be doing it," he said. "Investors would be more skeptical and demanding a discount."

Musk's own track record does not hurt. Tesla went public in 2010 and $1,000 invested in the electric vehicle company then would be worth about $262,000 today. The company has a more traditional one-share, one-vote structure.

The logic of dual-class structures is that giving founders more control leaves them the latitude to avoid short-term thinking and pour money into the company even if there is no immediate payoff.

While it has a traditional structure, supporters of the founder-centric scheme often cite Amazon.com Inc. as an example of a company that didn't turn a profit until a dozen years after it went public. An impatient group of shareholders might have forced the company to curb spending at the cost of its long-term growth.

"What's different with tech companies is you might have big, upfront costs and there's the potential to earn big profits in the future," Ritter said, citing AI companies that include Anthropic PBC and OpenAI Inc. - both of which have filed confidential draft registration statements with the SEC.

Lindsey Stewart, director of institutional insights with Morningstar Europe Ltd., said the problem with SpaceX is that Musk could sell half of his shares and still maintain control of the company. Large funds don't have much choice but to own it, given the company's size.

SpaceX ended its first day of trading as the sixth-most valuable U.S.-listed company even though it is not profitable and has no near-term prospects of doing so.

"Clearly, the market does have the option of voting with its wallet but given the eventual size that SpaceX and similar companies could grow to - once the free float in those businesses rises as lockups expire - they will start to represent a considerable portion of, say, the U.S. large-cap equity market, and by extension, the global equity market," he said.

"And so, investment managers and other fiduciaries would need to take a very active decision to overweight, underweight or exclude that company," Stewart added.

Not all companies with dual-class structures have turned out to be successful, and a string of companies that have gone public in recent years have failed spectacularly after their IPOs.

"It's fair enough that every now and then there's a superstar entrepreneur - an Elon Musk or Warren Buffett [who recently stepped down as CEO of Berkshire Hathaway Inc.], that could deliver outstanding returns for investors - but those individuals are few and far between," Stewart said.

Charles Elson, founding director of the Weinberg Center for Corporate Governance and a retired professor at the University of Delaware, is a pointed critic of dual-share arrangements, saying it eliminates accountability by removing the ability of shareholders to remove company leaders.

"It is literally giving your money away to someone with the hope that they will treat you fairly and always make the right decisions," he said. "Anyone who is not accountable gets in trouble in the end."

"The idea that dual-class stock is the reason to be successful is silly," Elson said, citing examples such as Microsoft Corp., Apple Inc. and the poster child for long-term planning: Amazon as one-share, one-vote companies that have thrived.

But in a 2024 paper for the Harvard Law School Forum on Corporate Governance, Yale University professors Jeffrey Sonnenfeld and Steven Yian said their research revealed that companies with dual-class shares have outperformed those with single-class shares both over one year and over a decade - although not by much.

For all the legitimate concerns, Sonnenfeld and Yian wrote that dual-class shares "facilitate easier execution of strategy; insulate the firm and management from short-termism, including activist shareholders; protects firms making capital expenditures with long pay-off horizons, and attracts the right kind of institutional investment partners with long-term investment horizons."

One compromise solution that some companies have adopted in their IPOs is a sunset provision, in which founders maintain control but only for a limited period of time.

Lucian A. Bebchuk, director of the Program on Corporate Governance at Harvard Law School and a critic of dual-class stock structures, said sunset provisions after 10 or 15 years are a good idea.

"The case for sunset provisions is compelling," he said. "No matter how outstanding a founder-CEO is at a given point in time, there is a growing risk over time that the founder-CEO will no longer be the most fitting leader. A perpetual dual-class structure is contrary to the interest of public investors and the economy."

But while some companies have adopted sunset provisions, many others have not, even though some corporations have run into trouble because of fraud or because a company leader remained in power too long.

And if investors stay optimistic, dual-class structures will probably stay popular - until there is a major problem with such a company.