Disproportional Control and Insider Entrenchment: Evidence from Capital Structure Choices and Institutional Investment

Abstract

A dual-class ownership structure, accompanied by disproportional control rights, is traditionally considered to be an inferior form of governance. We examine how the capital structure choices made by dual-class firms (i.e., by their controlling shareholders or insiders), as well as the investment choices made by the non-controlling institutional investors in these firms, vary with the presence of dual-class ownership and the degree of disproportional control it entails. We consider two sources of disproportional control: the difference between voting rights and cash flow rights and the difference between board election rights and cash flow rights. We find that dual-class firms, as well as firms with higher levels of disproportional control, have higher levels of leverage, a greater likelihood of issuing private debt, a higher fraction of long-term debt, and greater reliance on financial covenants. We also find that dual-class firms have significantly higher levels of institutional ownership, including ownership by institutions that are activist types, face stricter prudence laws, and have longer horizons. Overall, our evidence is not consistent with dual-class ownership promoting rent-seeking behavior. On the contrary, our evidence supports the view that insiders choose other mechanisms, debt in particular, to commit to not expropriate non-controlling shareholders.