Corporate governance and firm value at dual class firms

• Author: Nataliya Zaiats,Ting Li
• Published date: 01 January 2018
• DOI: http://doi.org/10.1016/j.rfe.2017.07.001
• Date: 01 January 2018

ORIGINAL ARTICLE

Corporate governance and firm value at dual class firms*

Ting Li

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Nataliya Zaiats

2

1

Department of Management & Business,

Skidmore College, Saratoga Springs, NY

12866, United States

2

Sawyer Business School, Suffolk

University, Boston, MA 02108, United

States

Correspondence

Nataliya Zaiats, Sawyer Business School,

Suffolk University, Boston, MA 02108,

United States.

Email: tli@skidmore.edu, nzaiats@suffolk.

edu

Abstract

This study explores whether corporate governance at dual class firms differs from

that of their single class counterparts and whether firm value at dual class firms is

associated with governance. Employing a sample of 1309 U.S. dual class firm-

year observations for the period 1996–2006, we show evidence that dual class

firms are more likely to employ more shareholder rights provisions while exhibit-

ing lower board and board committee independence than single class firms. The

results also show that shareholder rights increase while board provisions decrease

in wedge at dual class firms. Further findings underscore that firm value at dual

class firms decreases in wedge, and increases in shareholder rights and in board-

related provisions, particularly in director independence. While strong board-

related governance at dual class firms is significantly positively related to firm

value in a multivariate setting, shareholder rights are significantly associated with

firm value only in instances of the weakest board provisions. Following unifica-

tion, firms employ more antitakeover provisions while strengthening their board

and board committee independence.

JEL CLASSIFICATION

G32, G34

KEYWORDS

Corporate governance, Dual class firms, Firm value, Unification

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INTRODUCTION

Dual class ownership structure represents the strongest anti-takeover provision, and thus firms with dual class status are

practically immune to a hostile takeover. Gompers, Ishii, and Metrick (2009) (Gompers et al., 2009 thereafter) report that

about 6% of public companies in the U.S. during 1995–2002 have more than one class of common stock. Notably, a num-

ber of prominent firms such as Google, Facebook, Nike, and Polo Ralph Lauren employ dual class ownership structure to

retain their voting power. Since the NYSE abandoned the requirement of listing with only one share class in 1986, firms

with dual class ownership structure have gathered strong attention in empirical research in finance and economics. Specifi-

cally, prior literature focuses on agency problems, abnormal returns, and firm values. Herein, we investigate whether corpo-

rate governance at dual class firms differs from that at single class firms and whether governance at dual class firms is

related to firm value.

*We are grateful for the insightful suggestions and comments from the editor Tarun Mukherjee, three anonymous reviewers, Lilian Ng, Hung-Chia Hsu,

Yong-Cheol Kim, Richard Marcus, Valeriy Sibilkov, Daewoung Choi, Brian Bolton, and James G. Tompkins, as well as participants of 2015 Annual

Meeting of the Financial Management Association in Orlando, 2015 Annual European Conference of the Financial Management Association in Venice,

and 2011 Annual Meeting of Southern Finance Association in Key West. All remaining errors are our responsibility.

First published online by Elsevier on behalf of The University of New Orleans, 18 July, 2017, https://doi.org/10.1016/j.rfe.2017.07.001

Received: 14 September 2016

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Revised: 7 April 2017

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Accepted: 11 July 2017

DOI: 10.1016/j.rfe.2017.07.001

Rev Financ Econ. 2018;36:47–71. wileyonlinelibrary.com/journal/rfe ©2017 The University of New Orleans

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The divergence between voting and cash flow rights at dual class firms exacerbates the agency conflicts between man-

agers and the outside investors. Firm managers are therefore more prone to pursue private control benefits at shareholders’

expense. In line with the above argument, extant studies underscore the agency problems associated with dual class owner-

ship structure. For instance, Gompers et al. (2009) show that firm value is positively associated with insiders’cash flow

rights while negatively associated with insiders’voting rights. Masulis, Wang, and Xie (2009) document that large excess

control rights at dual class firms lead to both greater private benefits of control and reduced market value to the outside

shareholders. Li, Ortiz-Molina, and Zhao (2008) demonstrate that the level of institutional ownership is substantially lower

at dual class firms than at single class firms, and that the lack of shareholder voting rights at dual class firms is a key detri-

mental factor in the portfolio decisions of institutional investors.

To the best of our knowledge, no study to date has focused on corporate governance at dual class firms. Since dual

class status is the strongest antitakeover provision, it is important to assess whether and how dual class firms employ the

various alternative antitakeover mechanisms, as well as whether their board-related governance provisions diff er from those

at their single class counterparts. Further, it is of particular interest to document whether governance diff erences between

single and dual class firms and among the dual class firms help explain value implications at dual class firms. Although

dual class ownership structure allows insiders to retain strong voting power, the shareholder rights provisions, if available,

may protect the outside investors against the strongest antitakeover feature, represented by dual class status. It is also plau-

sible that dual class firms with stronger governance exhibit higher firm values than their counterparts with weaker gover-

nance, even after controlling for voting and cash flow rights divergence. Therefore, in this study, we answer the following

two questions. (1) Does corporate governance at dual class firms differ from that at their single class counterparts? (2) Are

governance provisions at dual class firms significantly associated with firm value?

We employ a comprehensive U.S. dual class firm database to examine corporate governance at these firms during

1996–2006. We draw on prior literature to identify five key antitakeover provisions and seven board-related provisions that

have previously been shown to affect shareholder rights or firm value. We examine these provisions individually as well as

construct additive indices to capture all shareholder rights provisions or board-related provisions - shareholder rights index

(SRI) and board-related index (BRI). Focusing on a sample of 1309 dual class firm-year observations, our results show that

dual class firms employ fewer antitakeover provisions (exhibit stronger shareholder rights), more of several key board-

related provisions associated with stronger governance, while exhibiting weaker board and board committee independence

than single class firms. Specifically, a larger proportion of dual class firms than of single class firms allow shareholders to

call special meeting, act by written consent, have no poison pill, no staggered board, and offer shareholders cumulative vot-

ing rights. A larger proportion of dual class firms than of single class firms exhibit a higher board meeting attendance ratio,

optimal board size (board size between 5 and 16 members), have CEO serving on 2 or fewer outside boards, and have sep-

arate chairman and CEO positions. More dual class firms, however, exhibit lower compensation committee, nomination

committee, and director independence. Firms with the above features are more likely (or less likely, as above, respectively)

to be dual class firms and the proportion of firms with the above provisions increases (or decreases, as above, respectively)

with divergence between voting and cash flow rights at dual class firms.

We further examine whether and how corporate governance adopted by dual class firms relates to firm value. We mea-

sure firm value as the industry-adjusted natural log of Tobin’sQ. We construct portfolios based on wedge (voting rights

minus cash flow rights) and shareholder rights index (SRI) or board-related index (BRI), respectively. The results show that

firm value increases in each wedge portfolio with an improvement in shareholder rights or in board-related governance.

The multivariate tests show that both the shareholder rights index and the board-related index are positively significantly

related to firm value. However, none of the individual shareholder rights provisions exhibits a significant relationship with

firm value. Among board-related provisions, director independence exhibits a positive significant link with value. Further

tests suggest that the strongest shareholder rights provisions relate positively to value only in instances of the weakest

board-related governance.

Finally, we assess whether and how the ownership structure change from dual to single class status affects firm-level

corporate governance. The goal of this pursuit is to provide further support to our key finding of the relationship between

firm-level corporate governance and dual class ownership structure. We find that following unification, the proportion of

firms allowing shareholders to call special meetings, act by written consent, those without a poison pill or staggered board

in place, or those that offer shareholders cumulative voting rights, declines. Such a change implies a fall in shareholder

rights for firms that can no longer enjoy the increased private control benefits associated with the dual class status. In turn,

the proportion of firms with stronger director independence as well as stronger nominating and compensation committee

independence increases following unification. We also find that dual class firms without a poison pill in place and those

that allow shareholders to act by written consent are less likely while those with stronger director indepe ndence are more

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LI AND ZAIATS