„Extreme Governance: An Analysis of Dual-Class Companies in the United States“ Gompers, Paul A., Joy L. Ishii, and Andrew Metrick

Question 1

What is the main idea?

Answer 1

The research summarizes dual-class firms in the US, provides reasons for their existence and insights about the valuation of such companies. Different strength of shareholder rights translates to different performance of firms and economies at large.

Question 2

What is the methodology used?

Answer 2

“Separation sample” – 40% of dual-class firms (insiders have >50% voting rights, <50% CF rights)

More possibility for analysing relation between insider ownership and firm value, because voting and CF rights are not linked; possible to separate incentive and entrenchment effects

1st construct a “candidate sample” – possible dual-class firms (share counts differ by +1% between 2 databases, and another)

350–500 dual class firms depending on year

For dual-class firms: median asset and market value is higher, more leveraged, significantly older, than single-class

Question 3

Who are insiders?

Answer 3

Disclosed group of officers and directors

Question 4

What are the main findings? (Regarding shareholder rights)

Answer 4

Strong protection of shareholder rights = Low PBOC = Shareholders expect to get a proper return.

Dual-class stock is the most powerful antitakeover protection.

Anti-takeover provisions are a widely accepted measure of shareholder rights. (More takeover defences = Less rights for the shareholders)

Conventional wisdom: Antitakeover defences entrench managers who run firms inefficiently and/or consume large PBOC. This leads to a decrease in firm’s value through lower operating performance.

Question 5

What is a dual-class firm?

Answer 5

Academia has ignored dual-class stocks: stocks whose holders have different rights to participate in the ‘life’ of the company.

Dual-class company:
1. Superior class with 10 votes per share, non-publicly traded.
2. Inferior class, with 1 vote per share, publicly traded.

Superior class = owned by company insiders (e.g., managers). It provides insiders with a majority of votes despite much lower cash flow rights in their possession. Insiders of dual-class firms have effective control over all corporate decisions. It makes them virtually immune to hostile takeovers.

Question 6

What does the data say about dual-class firms?

Answer 6

~ 6% of the publicly listed companies in the US are dual-class.

On average, the insiders own 60% of the voting rights and 40% of the cash flow rights = they bear considerably smaller financial consequences for their decisions.

Compared to single-class, dual-class firms are:
Bigger;
More levered (mby bc they’re reluctant to engage in equity offerings not to lose ownership or debt is used as an alternative control mechanism);
Older (less possibility of being acquired) = No abnormal returns by dual-class companies are documented.

Question 7

What are the determinants of dual-class status?

Answer 7

Predictors of larger PBOC and thus dual-class status?

1. Name (If the company is named after a founder, this might indicate a “personal” stake involved) Most powerful predictor
2. Media (Control of a media company provides opportunities for self-advertising, manipulating the public opinion)
3. Activity of the founder (If the firm is young and the founder is still active, PBOC and also dual-class structure is more likely)
4. Few other local firms (Only game in town, more wiggle room to extract monetary value from PBOC)
5. Large local firms (Need to protect against takeovers)
6. Sales of the firm relative to others going public in the same year are large

Superior shareholders enjoy PBOC. During the IPO, if PBOC from superior shares are larger than total value reduction from inferior shares, insiders that controlled the company up to the IPO (managers, founders) are willing to obtain a dual-class structure.

Question 8

What are takeover defences?

Answer 8

Things that make takeovers difficult & expensive:

Charter amendments: In firm’s charter, set conditions on control transfer (“shark repellent”). For example, Supermajority changes – require over 2/3 vote to approve merger.

Golden parachute: Firm’s senior management gets a generous severance package if the firm is taken over and the managers are let go.

Poison pills: Shares with rights to buy more shares in the target at a deeply discounted price: creates massive dilution for a potential corporate raider thereby making an acquisition prohibitively expensive.

Pac man defence: Target firm counteroffers for bidder firm: effective if target much larger than bidder.

Question 9

How does dual-class status affect firm value?

Answer 9

There is a a loop of causality between ownership structure and firm performance.

Firm value is:
o positively associated with insiders’ cash-flow rights
o negatively associated with insiders’ voting rights
o negatively associated with the wedge between the two

Evidence that dual-class system can reduce the value of the firm, but a majority owner of a private company can still rationally choose to sacrifice some of firm value to maintain PBOC.

Personal utility from controlling a newspaper, news agency or brand identity can well outweigh financial losses of the firm.

Question 10

How are dual-class firms valued?

Answer 10

Valuation measure is industry-adjusted Tobin’s Q = Market Value of company / Assets to replacement cost.