The Costs of Control-enhancing Mechanisms: How Regulatory Dualism Can Create Value in the Privatisation of State-owned Firms in Europe

Abstract

Empirical studies show that ownership structures that separate control and cash flow rights create agency problems and are associated with reduced value for minority shareholders. Institutional investors recognise these inefficiencies and expect a discount on the share price of companies with control-enhancing mechanisms like multiple voting rights shares or pyramidal ownership structures. In the US, corporate pyramids are discouraged through the taxation of intercompany dividends, whereas multiple voting rights shares are allowed but have to be issued before the firm goes public. Therefore, controlling shareholders who want to entrench themselves in control by retaining multiple voting rights shares pay the costs of this inefficient capital structure when the firm initially goes public at a discounted price. Some European countries — including Spain, Portugal, Greece and, until very recently, Italy — have adopted a diametrically opposite solution. Multiple voting rights shares have been expressly prohibited by the legislator, but corporate pyramids are commonly used by listed companies and can be created following the IPO of the firm without approval from the shareholders. In this situation, if institutional investors expect that a pyramidal ownership structure will be created in the future, they will discount the price of the shares when the firm goes public. Therefore, if Italy, Spain, Portugal and Greece are willing to privatise some of their state-owned companies and want to maximise the price of their stocks, they should create the conditions to assure the market that these companies will not be controlled through pyramids in the future. Because of strong opposition from national business elites which control the largest corporate groups, it is very difficult to adopt strict regulations aimed at prohibiting — or at least limiting — the use of pyramidal ownership structures in a relatively short period of time. In order to solve this Olson problem, I suggest that Italy, Spain, Portugal and Greece should use regulatory dualism to create new markets with enhanced corporate governance rules that prevent shareholders’ control through pyramids.