Mean Reversion between Different Classes of Shares in Dual-Class Firms: Evidence and Implications

Abstract

This paper analyzes the stocks with differential voting rights in the world for fractional cointegration. In the United States, I find that out of 101 firms with at least two classes of stocks traded publicly, 81 (80%) are fractionally cointegrated. The mean (median) estimated long-memory parameter of the equilibrium is 0.61 (0.65) and is negatively correlated with the quality of the firm's corporate governance. The fractional cointegration among dual-class shares implies mean-reverting residual process if long-memory parameter is less than 1. It also implies predictability of future returns using the past prices. A simple long-short strategy based on the cointegration regression residuals yields substantial abnormal returns, even after controlling for market, size, book-to-market, momentum, liquidity, and investor sentiment. Extending the analysis to the rest of the world, I find that out of 788 firms with dual-class shares traded publicly, 470 (60%) are fractionally cointegrated. The long-memory parameter for a country is negatively correlated with quality of its investor protection.