Dual-class Companies Research Articles

Synthetic Governance

Although securities regulation is distinct from corporate governance, the two fields have considerable substantive overlap. By increasing the transparency and efficiency of the capital markets, securities regulation can also enhance the capacity of those markets to discipline governance decisions. The importance of market discipline is heightened by the increasingly vocal debate over what constitutes “good” corporate governance.
 Securities product innovation offers new tools to address this debate. The rise of index-based investing provides a market-based mechanism for selecting among governance options and evaluating their effects. Through the creation of bespoke governance index funds, asset managers can create indexes that correspond to investors’ governance preferences. We argue that this “synthetic governance” offers a way to gather evidence on the economic impact of corporate governance by providing a market-based tool for evaluating the relationship between corporate governance and stock returns.
 We illustrate the potential of synthetic governance by creating a new governance-based index, the Dual Index, which selects portfolio companies on the basis of a dual class voting structure and comparing its performance to various benchmarks. We further modify the Dual Index by implementing synthetic sunsets to highlight the value creation of dual class companies in their early years and provide evidence on the appropriate length of a time-based sunset provision. Finally, we expand our analysis of synthetic governance with a second index—the Split Index—which tests the effect of separating the positions of CEO and chairman of the board. We conclude that synthetic governance demonstrates the ability of securities market innovation to discipline corporate governance.

Every sunset is an opportunity to reset: an analysis of dual-class share regulations and sunset clauses

ABSTRACT The dual-class structure tends to increase the agency costs associated with concentrated ownership, such as those stemming from self-dealing and poor-quality management. While corporate law addresses some agency problems, it is unable to eliminate all agency problems without unduly restricting the freedom of corporate controllers to manage their firms. This article uses theory-based and empirical approaches to demonstrate that a specific type of sunset clause may strike the right balance between, on the one hand, addressing agency problems and, on the other hand, providing an effective incentive for controllers of dual-class companies to increase firm value over the long term. The article evaluates current regulatory responses to the dual-class structure in selected jurisdictions and concludes that the existing arguments against mandatory sunset rules may be flawed. We suggest that a time-based sunset rule may be suitable for high-tech and innovation startups characterised by high-growth rates and low profitability.

Permitting dual class shares in the UK premium listing regime – a path to enhance rather than compromise investor protection

AbstractUnequal voting rights arrangements under dual class share structures are increasingly favoured by entrepreneurs and founders of technology companies, in order to retain a degree of control over the company that is disproportionate to their equity shareholdings. The rise of such share structures around the world has put competitive pressure on the UK Government and the country's financial regulator to relax the one share, one vote principle in the premium listing regime of the London Stock Exchange, to ensure the UK equities market remains world-leading and fit for the future development of the economy. There is, however, a long tradition of institutional investors’ distaste for dual class share structures. In fact, the near extinction of dual class listings in the UK capital markets can be largely attributed to the opposition of large British institutions. Therefore, this paper will critically discuss the conflict between the demands to attract listings from high-tech and innovative companies and concerns of a race to the bottom in the UK context. It rebuts criticisms based on investor protection and argues that if dual class companies were permitted to list in the Premium Segment, the higher level of regulatory protection provided in the premium listing regime would help enhance minority shareholder protection and shareholder engagement. The additional safeguarding measures, as we have seen from other global financial centres, would also help to restrain the potential abuse of controllers’ weighted voting power. Together with the market mechanism, permitting dual class listings in the Premium Segment should be welcomed.

Agency Conflicts and the Marginal Value of Capital Expenditure in Australian Listed Companies

We examine the value implications of Jensen’s free cash flow hypothesis for a sample of Australian listed companies. Consistent with the US evidence in Masulis, R, C Wang and F Xie (2009). Agency problems at dual-class companies. Journal of Finance, 64(4), 1697–1727, we find that the marginal value of corporate capital expenditures in Australian listed companies is inversely related to the magnitude of agency conflicts arising out of the use of free cash flows. Our results suggest that firms where managers have a greater ability to extract private benefits and are therefore more likely to maximize their own private benefits rather than shareholder wealth will suffer from a lower perceived valuation of their capital investments. Our findings are robust to alternative proxies for relative cash flows and growth opportunities and also hold over multiple sub-periods and industry groupings.

Institutional ownership of dual-class companies

Purpose This study aims to examine institutional ownership of companies that go public with dual-class share structures. Design/methodology/approach Several recent studies have discussed the potential advantages and disadvantages of the dual-class structure, which allows founders and insiders to maintain control of the firms they created through superior voting rights. Institutional investors oppose the dual-class structure, arguing that inferior voting rights make it difficult to respond to poor governance or performance. Previous research has shown the early value-added to the dual-class firm declines through time. This study examines institutional ownership of dual-class companies through time and compares institutional investments in initial public offerings with perpetual superior-class structures versus those with provisions to sunset those shares to one-share, one-vote structures. Findings Evidence suggests that institutional investors view perpetual dual-class structures as potentially riskier in terms of poor governance or performance and prefer dual-class companies with sunset provisions. Originality/value This study suggests that founders and insiders should consider either the dual-class structure with a sunset provision or if they choose the perpetual dual-class, it should include some type of event-driven safeguards.

Sunrise, Sunset: An Empirical And Theoretical Assessment of Dual-Class Stock Structures

A battle is brewing for control of America’s most dynamic companies. Entrepreneurs are increasingly seeking protection from interference or dismissal by public investors through the adoption of dual-class stock structures in initial public offerings. Institutional investors are pushing back, demanding that sucks structures be abandoned or strictly limited through subset provisions. The actual terms of dual-class stock structures, however, have been remarkably understudied, so the debate between proponents of prohibition and private ordering is ill-informed. This paper presents the first empirical analysis of the initial, or sunrise, and terminal, or sunset, provisions found in the charters of dual-class companies, with a data set of 139 U.S. pubic companies. Careful selection of such provisions can satisfy both the desire of entrepreneurs to pursue their idiosyncratic visions for value creation without fear of interference or dismissal and the need of investors for a voice to ensure management accountability. Private law firms representing entrepreneurs in initial public offerings play a critical role in the selection of charter provisions, so the onus is on such firms to ensure that private ordering produces a satisfactory resolution before momentum builds for a regulatory solution to investors’ concerns.

Determinants of Differential Voting Rights Share Prices and Ordinary Share Prices : Evidence from Dual-Class Companies in India

We analyzed the effects of Indian factors namely, Nifty index, Volatility index (VIX), and Economic Policy Uncertainty Index (EPUI) and United States of America (USA) factors such as S&P 500 Index, CBOE VIX, and EPUI on differential voting rights (DVRs) share prices and ordinary share prices of three dual-class companies in India during the monthly period from January 2012-August 2019 using quantile regression approach. We found quite interesting and useful results. In case of dual-class shares of Jain Irrigation Systems, DVR share prices were significantly influenced by Nifty and S&P 500. In contrast, USA VIX and Indian & USA EPUI had less impact on DVRs. We noticed an insignificant dependence between India VIX and DVRs across different quantiles. Further, impact of Nifty, S&P 500, India VIX, USA VIX, and USA EPUI on ordinary share prices varied across the quantiles; whereas, India EPUI had no influence on ordinary shares' prices. Regarding dual-class shares of Tata Motors, Nifty and S&P 500 had a significant impact on DVRs. However, DVRs were less sensitive to rest of the factors. For ordinary share prices, S&P 500 had a significant influence. However, the effects of other variables on ordinary share prices were not uniform across the quantiles. With respect to dual-class shares of Future Enterprises, both DVRs and ordinary share prices were highly affected by all the variables, except ordinary share prices were not exposed to India VIX.

SNAP Judgment: Unequal Voting and the Business Judgment Rule

Increasingly, company founders have been opting to shore up control with voting structures that undercut shareholder voting power, where only a decade ago almost all chose the standard and accepted one-share, one-vote structure. Now, with Snap's new no-vote structure, a controller can reduce her stake to only a penny and still hold onto control. These low- and no-vote stock ownership structures drastically undercut shareholder influence, undermine corporate governance, and will shift the burden of investment grievances to the courts. In reviewing board action, courts have historically taken comfort in the fact that, even at controlled companies, markets and corporate democracy will usually do a good enough job constraining management. Dual-class controlled companies, however, are fundamentally different. Unlike at a single-class controlled company, for a dual-class controlled company, there may be neither market incentives nor board oversight. Without board direction and market forces protecting shareholder interests, there is little justification for judicial restraint under the business judgment rule, so the burden of monitoring investments will end up in the courts. The judiciary must determine whether to add heightened review of operational decisions at dual-class controlled companies to the already heightened review of interested transactions. The alternative is promoting a new class of unaccountable and unmotivated corporations.

The Case for Dual-Class of Shares

The debate over whether dual class of shares increases or decreases share value, should be prohibited or not, should be subjected to mandatory sunset provisions, and so on has been heating up over the last few years. This paper reviews the pros and cons of dual class of shares in light of more recent empirical results of (mostly) American studies. The paper surveys the evolution of dual-class companies in the Canadian context and makes a number of recommendations to enhance the usefulness of this type of capital structure and protect the rights of minority shareholders. The paper comes out against time-based sunset clauses but supports the obligation for dual-class companies to adopt a “coattail” provision, as is the case in Canada, which provision ensures that all shareholders will have to be offered the same price and conditions should the controlling shareholder decide to sell its controlling stake in the company. The paper also recommends that separate tallies of vote results be made public for each class of shares and that a third of board members be elected by shareholders with “inferior” voting rights. Not only is there growing evidence of their better economic performance but the coupling of dual class and family ownership brings about longer survivorship, better integration in the social fabric of host societies, less vulnerability to transient shareholders and more resistance to strategic and financial fashions. This precious form of ownership must come with appropriate measure to ensure and protect the rights of minority shareholders.

The Lifecycle Theory of Dual-Class Structures

This academic presentation, based on our joint work on dual-class structures, was delivered by Lucian Bebchuk as his keynote address to the December 2018 ECGI-BIU conference on differential voting structures. The presentation focuses on the lifecycle theory of dual-class structure introduced in Bebchuk and Kastiel, The Untenable Case for Perpetual Dual-Class Stock, 2017 (https://ssrn.com/abstract=2954630). The presentation begins with discussion of precursor works to, and the motivation for developing, the lifecycle theory. The presentation then proceeds to describing the elements of the theory. In particular, it explains the reasons for expecting the efficiency benefits of dual-class structures to decline over time; for the efficiency costs to increase over time; and for controllers to choose to retain a dual-class structure even when it ceases to be efficient. The presentation also discusses a number of cases that vividly illustrate arguments advanced by the lifecycle theory. Among cases discussed are dual-class companies Viacom, CBS, and Facebook, as well as single-class companies Amazon, Microsoft and Yahoo!. We also explain that time-based sunsets can address the identified problems, and we discuss the design of, and objections to, such sunsets. Finally, we discuss the influence that our lifecycle theory has had on subsequent policy discourse and on empirical work testing the theory’s predictions. The presentation concludes that the lifecycle theory has solid theoretical foundations and is confirmed by recent empirical testing. We hope that the lifecycle theory that we introduced will continue to prove useful for researchers and policymakers and to contribute to the adoption of dual-class sunsets.

Governance by Business Decision: Dividends and Shareholder Voting

For dual-class companies, stock dividends have become a potent weapon for corporate boards to reallocate control without shareholder intervention. For example, the CBS board proposed to distribute voting stock to all shareholders to drastically dilute the controlling shareholder’s voting power. By contrast, the Google board issued new non-voting stock to all shareholders to perpetuate the controlling shareholders’ lock on control. In both cases, the pro rata distribution of the identical stock seemingly treats all shareholders equally, but it has a starkly unequal impact on each class’s voting power. Are such governance changes by stock dividends within board discretion? The level of board discretion in making stock dividends is primarily governed by each company’s corporate charter, and this Article presents the original, hand-collected data of charter provisions on stock dividends from 222 dual-class companies. The analysis of the charter provisions shows diverse approaches to stock dividends across companies. Largely due to such heterogeneity, interpretation and limitation of charter provisions are often uncertain. At the same time, courts have long treated dividends as boards’ business judgment and declined to second-guess their substantive merits as long as dividends are pro rata. Given the potential impact on corporate governance, however, the need for a distinctive treatment of stock dividends is long overdue. The Article also offers normative suggestions to fill the legal vacuum over stock dividends. First, as an ex ante mechanism, state corporate statutes can provide a set of default provisions on stock dividends to guide companies. Second, as an ex post remedy, the business judgment rule protection should be limited to the narrowly defined pro rata stock distribution (i.e., proportional distribution within the same class of stock). Non-pro rata stock dividends without the approval by adversely affected class should be subject to heightened judicial scrutiny. This is because such stock dividends are not driven primarily by business purpose, are not pro-rata, and sometimes raise concern over the directors’ promotion of self-interest.

The Perils of Small-Minority Controllers

This Article contributes to the long-standing and heated debate over dual-class companies by placing a spotlight on a significant set of dual-class companies whose structures raise especially severe governance concerns: those with controllers holding a small minority of the company’s equity capital. Such small-minority controllers dominate some of the country’s largest companies, and we show that their numbers can be expected to grow. We begin by analyzing the perils of small-minority controllers, explaining how they generate considerable governance costs and risks and showing how these costs can be expected to escalate as the controller’s stake decreases. We then identify the mechanisms that enable such controllers to retain their power despite holding a small or even a tiny minority of the company’s equity capital. Using a hand-collected analysis of governance documents of these companies, we present novel empirical evidence of the current incidence and potential growth of small-minority and tiny-minority controllers. Among other things, we show that governance arrangements at a substantial majority of dual-class companies enable the controllers to reduce their equity stake to below 10% and still retain a lock on control, and that a sizable fraction of such companies enable retaining control with less than a 5% stake. Finally, we examine the considerable policy implications that arise from recognizing the perils of small-minority controllers. We first discuss disclosures necessary to make transparent to investors the extent to which arrangements enable controllers to reduce their stake without forgoing control. We then identify and examine measures that public officials or institutional investors could take to ensure that controllers maintain a minimum fraction of equity capital; to provide public investors with extra protections in the presence of small-minority controllers; or to screen midstream changes that can introduce or increase the costs of small-minority controllers.

Dual-Class Index Exclusion

One of the most contentious and long-standing debates in corporate governance is whether company founders and other insiders should be permitted to use multi-class stock structures with unequal votes to control their companies while seeking capital through a public listing. Stymied by the permissive attitudes of legislatures and regulators, institutional investors opposed to multi-class arrangements recently turned to a new potential source of regulation: benchmark equity index providers. At the behest of institutional investors, the three largest index providers recently changed the eligibility requirements for their benchmark equity indexes to exclude, limit or underweight companies with multi-class stock structures. Investors expected the prospect of exclusion from such indexes to discourage founders and directors from adopting dual-class stock structures in connection with their initial public offerings. While there is a voluminous financial literature on the effects of index inclusion and exclusion on stock prices, and legal scholars have recently explored the corporate governance implications of the exponential growth of passive index investing, focusing primarily on the incentives of index fund asset managers, neither the financial nor the legal literature have considered the corporate governance role and influence of the parties who write the rules for index investing: the index providers. We begin to fill this gap in the literature by assessing the efficacy of index providers as corporate governance arbiters through the rubric of their dual-class index exclusion decisions. We start with the premise that the index exclusion sanction will not discourage dual-class listings unless it is sufficiently costly to outweigh the perceived benefits of founder control through a multi-class stock structure. We expect the index exclusion sanction will not be sufficiently costly for several reasons. First, it is difficult, if not impossible, to implement a sanction through the public capital markets. Second, the index inclusion effect on which the anticipated sanction is premised has effectively disappeared in recent years and may never have been a long-term source of lower capital costs. Third, despite the explosive growth of index investing in recent years, funds following stock indexes still hold a relatively modest percentage of the market capitalization of U.S. equities – around 12% according to BlackRock. Finally, the proliferation of index investing opportunities has weakened the market-moving influence of any one benchmark index. To test the efficacy of the sanction, we conduct an event study of the S&P announcement that dual-class companies would henceforth be excluded from the S&P 1500 Composite Index and its components – the S&P 500, S&P 400 mid-cap and S&P 600 small-cap indices. Because S&P grandfathered dual-class companies currently in the index, we are able to compare movements in the stock prices of dual-class companies currently in the index with movements in the stock prices of dual-class companies not yet included in the index at the time of announcement. We do not observe any statistically significant abnormal returns in the stock prices of either included or excluded firms as a result of the S&P announcement, suggesting that exclusion is not expected to have a significant adverse cost of capital effect on firms that elect to list with a dual-class stock structures in the future and the sanction is ineffective. In the absence of an effective sanction, the exclusion of dual-class shares from benchmark equity indexes will not affect corporate governance choices. It may, however, have material adverse consequences for index investors and the index providers themselves.

Sunrise, Sunset: An Empirical and Theoretical Assessment of Dual-Class Stock Structures

A battle is brewing for control of America’s most dynamic companies. Entrepreneurs are increasingly seeking protection from interference or dismissal by public investors through the adoption of dual-class stock structures in initial public offerings. Institutional investors are pushing back, demanding that such structures be abandoned or strictly limited through sunset provisions. The actual terms of dual-class stock structures, however, have been remarkably understudied, so the debate between proponents of prohibition and private ordering is often ill-informed. This paper presents the first empirical analysis of the initial, or sunrise and terminal, or sunset provisions found in the charters of dual-class companies, with a data set of 123 U.S. public companies. Careful selection of such provisions can satisfy both the desire of entrepreneurs to pursue their idiosyncratic visions for value creation without fear of interference or dismissal and the need of investors for a voice to ensure management accountability. Private law firms representing entrepreneurs in initial public offerings play a critical role in the selection of charter provisions, so the onus is on such firms to ensure that private ordering produces a satisfactory resolution before momentum builds for a regulatory solution to investors’ concerns.

Disproportional Control Rights and the Governance Role of Debt

We examine the governance role of debt in the context of U.S.-based dual class ownership structures. We hypothesize that the use of debt alleviates the conflict between shareholder classes by balancing the power of controlling insiders. We document that dual class firms have higher leverage and a greater propensity to issue private debt; they also more frequently use cash sweeps and performance-based covenants. Dual class firms with greater agency conflicts and a greater need to access the capital market appear to rely more extensively on debt. These findings are consistent with controlling insiders bonding against the agency costs associated with dual class ownership. The governance role of debt is further corroborated by the valuation effect of debt for dual class companies. Private debt issuances trigger greater positive market reactions to the inferior dual class stock in relation to both the superior dual class stock and a matched sample of single class firms. Further, leverage attenuates the previously documented adverse effect of dual class status on Tobin’s q. Taken together, our analyses suggest that dual class firms use debt as a complementary governance mechanism. This paper was accepted by Mary Barth, accounting.

Empresas Dual Class: Um estudo do impacto no valor das empresas Brasileiras

From the ‘Agency Theory' and the conflict of interest assumption the aim of this study is verify the impact of the use of two classes of shares (dual class) on the value in brazilian companies. The sample consisted of non-financial traded companies, with concentrated ownership structure, data are available in Economatica®, totaling 354 companies and 1,915 observations. The data refer to the period 2005 to 2012. It terms of methodology, to research the hypothesis of the study it was used a regression by ordinary least squares, with panel data. The results indicate that companies using two classes of shares, such as separation mechanism between the cash flow and the equity control, have lower value then the ones not using such a mechanism. Additionally, it can be inferred that the governance levels and the higher dividend payment policy in the preferred shares are not able to mitigate the higher level of conflicts of interest and agency costs in dual class companies.

Analysis of dividend policy of dual and single class U.S corporations

Despite the extensive literature on dividend policy, little is known about the relationship between controlling shareholders and the determination of dividend policy, especially in dual class companies. Three potential dividend policy hypotheses are examined. We show that dual class companies pay out less cash dividends and repurchase fewer shares and that cash distributions decrease as the divergence of voting and cash flow rights widens. This is consistent with both the private benefits and family legacy hypotheses. However, an examination of executive compensation and family participation on the board indicates that lower dividends are consistent with the private benefits hypothesis.

An agency theory explanation of SEO underperformance: Evidence from dual-class firms

Using a sample of U.S. dual class companies, we empirically investigate the effects of the divergence between insiders’ voting and cash flow rights on market reaction to seasoned equity offerings (SEOs) and long-run stock performance following SEOs. We find that SEO announcement returns and long-run stock performance following SEOs are negatively related to measures of the divergence between insiders’ voting and cash flow rights. Our results support the view of agency theory as a plausible explanation of SEO underperformance. Misalignment of interests between insiders and outside shareholders can create managerial incentives to undertake value-destroying investments to extract private benefits, ultimately leading to a reduction in firm value.

Investor Protection and the Value of Shares: Evidence from Statutory Rules Governing Variations of Shareholders' Class Rights in an Emerging Market

This article uses a quasi-experimental framework provided by recent changes in Russian corporate law to study the effect of investor protection on the value of shares. The legal change analyzed involves the empowerment of nonvoting shareholders to veto unfavorable changes to their class rights. We take advantage of the presence of well-defined treatment and control groups and use the voting premium, a traditional measure of private benefits of control and shareholder expropriation, as the outcome variable. Based on a novel hand-collected dataset of dual-class stock companies in Russia and using a difference-in-difference regression analysis as well as an event study, we find a statistically and economically significant effect of improved protection of preferred shareholders on the value of their shares. The result is robust to several changes in the empirical specification. (JEL G30, G38, K22) The Author 2012. Published by Oxford University Press on behalf of Yale University. All rights reserved. For Permissions, please email: journals.permissions@oup.com, Oxford University Press.

To Extract or Not to Extract: An Examination of the Dual Class Discount, and the Channels of Extraction of Private Benefits

Several recent studies provide evidence that dual class firms are discounted compared to similar single class companies due to the extraction of private benefits and agency costs. However, the channels through which private benefits are extracted have not been fully explored in the literature. With a propensity score matched sample of S&P 1500 dual class and single class companies with concentrated control, this paper investigates the link between the observed valuation discount of dual class companies and three channels through which private benefits can be extracted: excess executive compensation, excess capital expenditure and excess cash holdings. This research provides evidence that excess compensation and excess cash holdings of dual class companies are directly related to the discount that investors apply to the value of dual companies. The findings indicate that excess compensation is paid to executives in dual class companies and the degree of excess compensation is greatest for executives who are family members. The results also show that dual class firms retain more cash compared to single class concentrated control firms. However, capital expenditure is not statistically significant in explaining the dual class discount.