Cremers, M., Lauterbach, B., & Pajuste, A. (2022). The Life Cycle of Dual-Class Firm Valuation. Flashcards
What is the initial valuation pattern of dual-class firms at IPO?
At IPO, dual-class firms exhibit a significantly higher valuation than matched single-class firms—on average, a 14% higher Tobin’s Q. This premium is strongest in firms where the founder retains a top management role, especially when the founder is young, indicating that the market values the vision and leadership preserved by the dual-class structure early in the firm’s life.
How does the valuation of dual-class firms evolve over time?
The valuation premium dissipates over time. On average, dual-class firms begin to trade at a discount compared to matched single-class firms 7 to 9 years post-IPO. This reflects a lifecycle where the initial benefits of founder vision are fulfilled or become less relevant, while the costs of entrenchment and agency problems increase.
What role does the “wedge” play in dual-class firm valuation?
The “wedge”—the gap between insider voting rights and equity ownership—widens over time as founders and insiders dilute their equity but retain control. This misalignment intensifies agency problems, such as entrenchment and value extraction. Firms with increasing wedges experience a significant decline in market valuation, confirming that the wedge is a key driver of long-term underperformance in dual-class firms.
How common are voluntary unifications of dual-class structures?
Voluntary unification—where a firm converts to a single-class share structure—is rare. Only about 20% of dual-class firms unify their shares within 10 years post-IPO. Moreover, the likelihood of unification declines with firm age, likely because founders would lose voting control and gain only a fraction of the valuation increase, making unification economically unattractive from their perspective.
What regulatory solution do the authors propose for managing dual-class structures over time?
The authors support a time-based “sunset clause” that would require public shareholders to vote on whether to maintain the dual-class structure approximately 7 years after IPO. This timing is based on their empirical finding that dual-class firms typically begin to trade at a valuation discount around year 7. Since dual-class firms are unlikely to unify voluntarily—even when it’s value-enhancing—this regulatory mechanism would protect minority investors by allowing the market to reassess whether the founder’s control is still value-adding.
What is the “wedge” in dual-class firms, and how does it affect firm valuation over time?
The wedge refers to the difference between insiders’ voting rights and their equity ownership. In dual-class firms, this wedge typically increases after the IPO because insiders (like founders) often sell low-vote shares while retaining high-vote shares, thereby diluting their economic ownership without losing control. The study finds that an increasing wedge is associated with a statistically significant drop in firm valuation over time, consistent with rising agency problems such as entrenchment and misalignment with outside shareholders. This supports the idea that the costs of the dual-class structure grow with age.
