Non-voting Stocks Research Articles

Involuntary Non-Voting Stock Due to War: Reflections and Solutions to Remaining Corporate Governance Issues for the Chinese Civil War

Modern wars have prohibited people from communication with one another for a long time. This separation has actually caused corporate governance problems. As an example, if a significant enough portion of shareholders cannot attend a shareholders’ meeting and vote, not only can no lawful resolutions be made due to mandatory quorum requirements, but those shareholders are easily oppressed by controlling shareholders. How can the law protect the property rights of shareholders who cannot attend such meetings while upholding efficient corporate governance? In this paper, we took the experience of the Chinese Civil War as an example to answer the questions. We did archival work on ad hoc legislation in 1964 and its amendment in 1992 in response to this situation. In addition, we scrutinized the solutions proposed during the legislative process, analysed them from a legal and economics perspective, and offer our own proposal. We found that the 1992 amendment freezes shareholders’ voting rights and deducts their shares when calculating the total number of shares. The involuntary non-voting stock policy deviates from the “one share one vote” principle and causes oppression indirectly; thus, it is obviously not an appropriate measure. We propose that auctioning those shares would be a more efficient and property-right-protective alternative to adopt.

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.

Nonvoting Shares and Efficient Corporate Governance

A growing number of technology companies, including Google, Facebook, and Snapchat, have chosen to issue stock that does not allow their investors to vote on corporate decisions. But scholars and investors are in fundamental disagreement about whether nonvoting stock is a benefit or a curse. Critics argue that nonvoting shares perpetually insulate corporate insiders from influence and oversight and therefore increase management agency costs. By contrast, proponents contend that even in spite of increased agency costs, nonvoting shares may provide benefits that exceed these costs, such as enabling corporate insiders to pursue their long-term vision for the company without interference from outside shareholders. This paper offers a novel perspective on this debate. It demonstrates an important and previously unrecognized benefit of nonvoting stock: it can be used to make corporate governance more efficient. This is because nonvoting stock allows companies to divide voting power between shareholders who are informed about the company and its performance and those who are not. When this efficient sorting happens, the company will lower its cost of capital by reducing agency and transaction costs. Specifically, informed investors will pay more for voting stock that is not diluted by uninformed investor voting; indeed, a company may even entice informed investors to invest by offering two classes of shares. Likewise, uninformed investors will more highly value shares that do not require them to incur costs associated with voting. In other words, the company that issues nonvoting shares for its uninformed shareholders to buy will make itself more valuable. And because nonvoting stock trades at a discount to voting stock, uninformed shareholders will have another reason to purchase nonvoting shares, obviating the need for legal intervention. This insight has several implications for law. Most important, this paper contends that recent proposals to restrict or deter companies from issuing nonvoting shares should be rejected because they may impede efficient corporate structuring.

A Private Ordering Defense of a Company's Right to Use Dual Class Share Structures in IPOs

The shareholder empowerment movement (movement) has renewed its effort to eliminate, restrict or at the very least discourage the use of dual class share structures in initial public offerings (IPOs). This renewed effort was triggered by the recent Snap Inc. IPO that utilized non-voting stock. Such advocacy, if successful, would not be trivial, as many of our most valuable and dynamic companies, including Alphabet (Google) and Facebook, have gone public by offering shares with unequal voting rights. Unless there are significant sunset provisions, a dual class share structure allows insiders to maintain voting control over a company even when, over time, there is both an ebbing of superior leadership skills and a significant decline in the insiders’ ownership of the company’s common stock. Yet, investors are willing to take that risk even to the point of investing in dual class shares where the shares have no voting rights and barely any sunset provisions, such as in the recent Snap Inc. IPO. Why they are willing to do so is a result of the wealth maximizing efficiency that results from the private ordering of corporate governance arrangements and the understanding that agency costs are not the only costs of governance that need to be minimized. In this essay, Zohar Goshen and Richard Squire’s newly proposed “principal-cost theory,” “each firm’s optimal governance structure minimizes the sum of principal costs, produced when investors exercise control, and agent costs, produced when managers exercise control,” is used to argue that the use of dual class shares in IPOs is a value enhancing result of private ordering, making the movement’s renewed advocacy unwarranted.

Accounting for Marketable Securities

This note provides an overview of intercorporate investments, including passive investments (marketable securities), investments that result in significant influence, and investments that result in control. Then, the accounting for marketable equity and debt securities is described in detail. Excerpt UVA-C-2280 Rev. June 30, 2009 ACCOUNTING FOR MARKETABLE SECURITIES Managers invest in securities of other companies for a variety of reasons. First, a company may have cash it would like to invest in the stocks or bonds of another company simply to generate a return. Second, a company may invest in another company so that it can influence that company's policies and performance. Third, a company may invest in another company to obtain control of that company. From a financial reporting perspective, these diverse reasons result in three broad investment categories: (1) passive investments, (2) investments that result in significant influence, and (3) investments that result in control. Passive Investments Passive investments are investments in securities of another company simply for the purpose of earning a rate of return. They can include investments in debt and equity securities. All debt securities (e.g., bonds) are considered passive investments—they generally do not result in the investing company having any significant influence or control of the company whose securities it has purchased. Although there are exceptions, investments in equity securities (e.g., stocks) are considered passive investments if the investing company owns less than 20% of the outstanding voting shares of the investee. Note that since preferred stock is typically nonvoting stock, it is usually considered a passive investment. . . .

Investment Strategies Based on Voting and Non-Voting Stocks

We measure the profitability of an investment in voting stocks, considering the prices of both voting and non-voting stocks. As Niehoff (2016) showed, non-voting stocks’ prices reflect new information on average faster than the prices of the corresponding voting stocks. To exploit this informational advantage, we apply the Q measure of stock mispricing suggested by Baule and Wilke (2016) to construct self-financing trading strategies based on mispriced voting stocks in the German and the Italian stock market. We analyze the risk-adjusted performance of these trading strategies and calculate their implicit trading costs for the 16-years period between 1997 and 2013. As our results show, suchlike strategies outperform several commonly used benchmarks and yield annual Fama-French-5-factor alphas of 11.9% before trading costs. If roundtrip trading costs do not exceed 0.5%, our trading strategies stay profitable and generate statistically significant abnormal returns in excess of well-established benchmarks as the 5-factor model of Fama and French (2015). Our overall findings therefore support the findings of Niehoff (2016) and suggest that individual investors could have exploited informational advantages existing in the non-voting stock market.

Price Discovery in Voting and Non-Voting Stocks

When closely related assets like voting and non-voting stocks of a company are traded on the same exchange, it is of interest in which type of stock price discovery takes place first. Price discovery has not been analyzed for such strongly linked assets as voting and non-voting stocks which are traded on one exchange. This paper examines price discovery in voting and non-voting German stocks using the widely applied price discovery metrics information share developed by Hasbrouck (1995) and the common factor weights developed by Gonzalo and Granger (1995) and Harris, McInish, and Wood (2002). We show that non-voting stocks react earlier on average. Thus, we can conclude that voting rights do not enhance the process of price discovery. Further, there is evidence that price discovery does depend on the turnover of the stocks.

Entrenchment and Investment

Corporate governance is on the reform agenda all over the globe. This paper shows that restrictions on the issuance of non-voting shares may cause managers who own equity in the firm to under-invest. When a firm issues voting shares to raise capital for new investment, there is a dilution in the manager's ownership. This increases the risk to the manager's control of the firm, decreasing his chances of obtaining the private benefits of control. The problem is most severe in firms where managers extract significant private benefits. Non-voting stock allows a firm to raise equity capital without a dilution in the manager's ownership and alleviates the under-investment problem. There are costs to the issuance of non-voting stock -- managerial entrenchment, dividend dilution and firms in the control of inferior managers. The issuance of non-voting equity is optimal when the benefits, higher firm value because of higher investment, outweigh the costs of managerial entrenchment. We obtain conditions under which it is optimal for firms to issue non-voting stock. Our theory is consistent with the empirical findings of Faccio & Masulis (2005) who show that a fear of loss of control makes shareholders reluctant to issue voting equity to finance M&A activities. In addition, our model produces new empirical predictions regarding the relationship between the likelihood of dual-class recapitalization and incumbent management quality, management ownership and the effectiveness of other mechanisms to restrict private benefits.

The determinants of the voting premium in Italy: The evidence from 1974 to 2003

We examine the voting premium in Italy in the period 1974 to 2003, when it ranged from 1% to 100%. At firm level, the measure of the price differential between voting and non-voting stocks cannot be fully explained without taking into account the effect of the largest shareholder’s identity. Family-controlled firms have higher voting premiums, especially when the family owns a large stake in the company’s voting equity and the founder is the firm’s CEO and/or Chairman. We explain this result by showing that families attach greater importance to control and are more prone than other types of controlling shareholders to expropriate the non-voting class of shareholders.

The Determinants of the Voting Premium in Italy: The Evidence from 1974 to 2003

We examine the voting premium in Italy in the period 1974 to 2003, when it ranged from 1% to 100%. At firm level, the measure of the price differential between voting and non-voting stocks cannot be fully explained without taking into account the effect of the largest shareholder's identity. Family-controlled firms have higher voting premiums, especially when the family owns a large stake in the company's voting equity. We explain this result by showing that families attach greater importance to control and are more prone than other types of controlling shareholders to expropriate the non-voting class of shareholders.

Non-Voting Shares and the Value of Control: The Impact of Corporate Regulation in Italy

Researchers have recently devoted their attention to the relationship between corporate and securities laws and the development of stock markets, claiming that high quality regulation, by reducing private benefits of control, stimulates broader and deeper capital markets. This paper tries to assess the impact of changes in Italian corporate law on private benefits during the twelve-year period 1989-2000. In this period, the Italian legislator introduced the mandatory bid rule (law 149/1992) and moved towards a higher protection of minority shareholders (through the legislative decree 58/1998). The paper focuses on these regulatory changes by analysing the evolution of the so-called voting premium, i.e. the price differential between voting and non-voting stocks, which might be regarded as a good proxy of private benefits of control. The analysis involves 80 publicly traded firms and supports the hypothesis that, along with the company's ownership structure, the liquidity and the fiscal treatment of non voting stocks as well as market factors (such as interest rates and traded volumes), the institutional framework matters. In particular, the estimation results show that the voting premium increased by about 2 percentage points after the introduction of the mandatory bid rule in 1992 and drop by about 7 percentage points following the enactment of the new corporate governance rules in 1998. The behaviour of voting and non-voting share prices during the period is thus consistent with the hypothesis that the expropriation of minority shareholders decreased after 1998.

Non-linear Error Correction and the Efficient Market Hypothesis: The Case of German Dual-Class Shares

Abstract The efficient market hypothesis implies that (risk-adjusted) asset prices cannot be cointegrated. On the other hand, arbitrage processes prevent prices of fundamentally related assets from drifting too far away. An attractive model that reconciles these two conflicting facts is the non-linear error correction mechanism (ECM). Such a process tolerates small deviations from the long-run relationship. For more substantial deviations, an effective adjustment process pushes the diverging prices towards their fundamental relationship. In this paper parametric and non-parametric techniques are employed to investigate the ECM between prices of voting and non-voting stocks. Despite its intuitive appeal, we find little evidence for a non-linear relationship between German dual-class shares. Only in four out of 12 cases does the threshold ECM yield a substantial improvement of fit. In other cases, the evidence for non-linearity is rather weak and the threshold ECM fails to outperform the linear model.

Similarly traded securities: Greek common vs. preferred stock

This paper examines the price spread between voting (common) and non-voting (preferred) stocks during the period 1990–95 for a sample of 55 Greek companies. Because in Greece preferred stocks are not essentially different from common stocks, a number of hypotheses were tested to explain the observed differences. The data reveal an average spread of 27.5% for the entire period which, however, varies across years considerably. In cross-sectional regressions it was found that the volatility of common stock returns, the liquidity of common shares relative to preferred shares, the ownership concentration, and the minimum dividend yield guaranteed to preferred stockholders explain a significant portion of the spread.

A theoretical analysis of the liquidity risk premium embedded in the prices of voting and non-voting stocks

Liquidity risk and corporate control considerations affect shareholders' willingness to invest in stocks and should thus be reflected in their prices. This paper derives the premium required by liquidity risk-averse agents who invest, respectively in non-voting and voting shares. It is shown that the liquidity risk premium depends upon the investor's risk aversion, the variance of his future consumption flow and the liquidation probability of each share type. Furthermore, liquidity risk premia depend upon the firm's capital structure decisions, the distribution and private valuation of voting rights by its shareholders.

Corporate groups, dual-class shares and the value of voting rights

It is known that deviating from the one-share–one-vote principle through the issue of non-voting stock increases the value of outsiders' voting rights. We argue that the creation of a business group is another way to deviate from one-share–one-vote and we show that it produces a larger voting-share premium in holding companies. As a consequence, having both subsidiaries and non-voting stock produces a multiplier effect on the voting premium. The puzzling size of the premium in Italy was never related to the interaction of pyramiding and non-voting stock. Our empirical study confirms that the premium is larger for holding companies issuing non-voting stock than for similar operating companies without non-voting equity.

Foreign direct investment, political resentment and the privatization process in eastern Europe

FDI Participation contracts would raise flows to eastern Europe Foreign direct investment has been disappointingly low in eastern Europe, which has been reluctant to make existing assets available to foreign investors. To mitigate any such resentment, we propose a participation model in which foreign investors compete for joint venture contracts. Host governments contribute existing assets and receive non-voting stocks. Foreign investors, contributing capital and know-how, receive voting shares and control of operational decisions. This has several advantages over the cash sale of assets to foreigners. First, stock flow problems are eased, raising both asset prices and FDI flows. Second, by retaining some stake in the firm, transition countries share in the risk premium. Third, governments can hand over their shares to households, creating private collateral to foster new small businesses. Fourth, and crucially, compared to cash sales the auction of participation contracts offers higher privatization revenues in cases where governments cannot assess investors' knowledge and abilities. This reduces the risk of selling the family silver too cheaply, and should alleviate the host countries' resentment. — Hans-Werner Sinn and Alfons J. Weichenrieder

ESOPs and corporate control

Abstract This paper examines the effects of employee stock ownership plans (ESOPs) on shareholder wealth. ESOPs established in the presence of takeover activity reduce share values, by approximately 4% on average. ESOPs also reduce share values if they are structured to transfer control away from outside shareholders, by creating a new ownership block with veto power over takeover bids. Large ESOPs established with nonvoting stock, so as to preclude any immediate control transfers, result in a significant increase in share values. The wealth effect of any given ESOP thus depends upon both its incentive and control effects on the corporation.

The value of the corporate voting right: Evidence from Switzerland

This paper analyzes the value of voting power of Swiss firms which usually issue high-voting- rights stock, low-voting-rights stock, and non-voting stock. Two variables measuring voting- power-inequality are constructed. They are both useful in explaining the voting-rights-premia. Also, the allocation of the voting rights is analyzed. It is shown that majority shareholders hold the high-voting-rights stock.

Corporations. Majority Stockholder Breaches Fiduciary Duty to Minority by Insisting That New Issue of Shares Be Non-Voting Where Issuance of Non-Voting Stock Is Grounds for Delisting by New York Stock Exchange

Corporations. Majority Stockholder Breaches Fiduciary Duty to Minority by Insisting That New Issue of Shares Be Non-Voting Where Issuance of Non-Voting Stock Is Grounds for Delisting by New York Stock Exchange

Is Non-Voting Stock Ethical?

Is Non-Voting Stock Ethical?