Extreme Governance: An Analysis of Dual-Class Companies in the United States Gompers, Paul A., Joy L. Ishii, and Andrew Metrick, 2010

Question 1

THE GENERAL CONSENSUS

Answer 1

Strong protection of shareholder rights = low PBOC = shareholders expect to get a proper return.
Anti-takeover provisions are a widely accepted measure of shareholder rights.
More takeover defenses = less rights for the shareholders.
Conventional wisdom: antitakeover defenses entrench (make it difficult to remove) managers who
run firms inefficiently and/or consume large PBOC. This leads to a decrease in firm’s value through
lower operating performance.

Question 2

WHAT IS A DUAL CLASS FIRM

Answer 2

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 shares with ten votes per share, non-publicly traded.
2. Inferior class, with one 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 3

STATISTICS

Answer 3

~ 6% of the publicly listed companies in the US are dual-class.
On average, the insiders own a majority of the voting rights (60%) and minority of the cash flow
rights (40%) = they bear considerably smaller financial consequences for their decisions.
Compared to single-class, dual-class firms are: Bigger on median terms ($295m versus $100m),
more levered, possible due to their reluctance to engage in equity offerings not to lose ownership
or it is possible that debt is used as an alternative control mechanism (18% versus 6% debt-to-assets
ratio), older, possibly due to less possibility of being acquired (12.9 years versus 9.6). = No
abnormal returns by dual-class companies are documented.
Also in the paper it is stated that 6% of dual-class firms own 8% of the total market, so they
are larger overall.

Question 4

DETERMINANTS OF DUAL-CLASS STATUS:

Answer 4

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 (e.g., managers, founders, VCs)
are willing to obtain a dual-class structure.
What predicts larger size of PBOC and thus dual-class status?
1. Name. If the company is named after a founder, this might indicate a “personal” stake involved.
2. Media. Control of a media company (e.g., newspaper, TV network) 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. Firms in the area & Sales of the area. The less firms there are in firm’s metropolitan area, the more likely the
firm is a major employer and “the only game in town”, which entails private benefits for insiders with dual-class
shares.

Question 5

WHAT ARE TAKEOVER DEFENSES

Answer 5

There are things that make takeovers very difficult and expensive.
Charter amendments: in firm’s charter, impose conditions on control transfer (“shark repellent”). For
example, Supermajority amendments – require over 2/3 vote to approve merger.
Golden parachute: an extremely lucrative severance package that is guaranteed to a firm’s senior
management in the event that the firm is taken over and the managers are let go.
Poison pills: securities with embedded rights to buy shares in either the target or an acquirer at a deeply
discounted price: creates massive dilution for a potential corporate raider thereby making an acquisition
prohibitively expensive.
Pac man defense: target firm counteroffers for bidder firm: effective if target much larger than bidder.
(The goal is to make the takeover attempt less attractive or manageable for the bidding company or to
put pressure on the bidder to negotiate terms more favorable to the target company.)

Question 6

REMARKS

Answer 6

There has always been criticism for dual-class shares: ownership structure is a variable that is also
determined by firm value and performance = a loop of causality between ownership structure and
firm performance (independent and dependent variables in this paper).
Firm value is positively associated with insiders’ cash-flow rights.
Firm value is negatively associated with insiders voting rights.
Firm value is negatively associated with the wedge between the two (insider voting rights – insider
cash flow rights).
Despite the evidence that dual-class system can reduce the value of the firm, 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.