Claims on Equity: Voting and Liquidity Differentials, Cash Flow Preferences and Financing Rights

Abstract

In conventional valuation, we assume that all equity claims are identical and divide the value of equity by the number of claims (shares) to get the value per claim (share). In practice, though, claims on equity can vary on a number of dimensions. First, the claim can be a direct and perpetual one (standard equity) or it can be contingent on the value changing (equity option). Second, some equity investors have preferential claims on the cash flows- dividends in some cases and cash flows in liquidation in other cases. Third, some equity claims have superior control rights over other claims: this can take the form of differential voting rights in some cases and a bigger role in board composition and management in others. In some instances, the power is triggered by a control event such as an acquisition or an initial public offering. Fourth, some equity investors are provided with special rights to protect their interests when the firm acts in later periods. These can include disproportionate rights in subsequent financing decisions - the right to partake in the financing at a fixed price, for instance, or veto rights over new financing - as well as redemption rights, where they can reclaim the capital that they have invested. Finally, equity claims can vary in terms of liquidity, with some claims being more marketable than others. All of these differences can affect value, resulting in some equity claims having higher value than others.