The business press commonly advocates for eliminating dual-class structures that provide corporate insiders with super-sized influence while simultaneously limiting their economic exposure. Standard and Poor’s recently announced they would bar new entrants with multiple classes of shares from the S&P 500 (Wall Street Journal, Aug 2., 2017). Academics describe super-voting structures as severely harming outside investors by shielding insiders from effective governance and market forces. In competitive markets, natural selection should eliminate governance mechanisms that destroy firm value. Remarkably, instead of disappearing, our analysis shows that dual class firms remain a popular choice, comprising nearly 1-in-10 public firms.
Our recent study, The Dual Class Premium: A Family Affair, investigates whether dual-class structures harm outside shareholders. We start with a simple question, ‘where do dual class share firms arise?’ We document a strong association between founding family ownership and dual class firms. Founders or their descendants control nearly 89% of dual class firms but only about 28% of single class firms. Notable differences exist between dual class and single class firms. Dual class firms tend to be relatively large, old and solid performers. Firms with super voting shares exhibit significantly greater return on assets (10.3%) relative to single class firms (8.5%). Within the dual class family-firm subset, family shareholders control over 31.0% of the cash flow rights and 58.1% of the voting rights. Single class family owners in comparison hold only 22.9% of their firms’ cash flow and voting rights. Thus, contrary to the popular narrative, family owners hold large economic exposure in dual class firms.
Existing evidence on limited voting shares focuses on comparing firm valuations in single and dual class firms. Our analysis provides similar comparisons but explicitly incorporates family control. We observe that dual class firms without family owners exhibit significantly higher valuations versus single class nonfamily firms (our benchmark). Dual class shares only exhibit lower valuations when the super-voting shares are held by family owners – about a 12% discount relative to the benchmark. Although dual class family firms sell at deep discounts relative to single class firms, investors presumably care about future stock returns. Investors are only harmed by dual class structure if, when buying shares, their investment provides inferior returns relative to other organizational forms.
When families hold the super voting shares, we find that dual class firms significantly and economically outperform all types of nonfamily firms. We find that a buy-and-hold strategy of dual class family firms earns excess returns of about 350 basis points more per year relative to the benchmark firms. Dual class firms without family owners earn similar stock returns as single class firms. Our analysis does not lend support to the notion that dual class structures harm outside investors. Rather, our results suggest that the dual class structure – in-and-of itself – has no effect on outside investors. When family shareholders own the super voting shares, however, we find the outsiders to earn a return premium on their investment; suggesting that family control plays a key role in the effect of dual class shares on minority shareholders. Investors demand a premium, across founder, descendant, and professionally managed firms, for holding dual class family firms.
To provide further insights on market participants’ perceptions of dual class structures, we examine whether institutional investors or retail investors hold the publicly available shares in dual class firms. We find that institutions hold 14 times more of the floated equity of limited voting family firms relative to single class firms. Rather than retail investors bearing greater risk in dual-class family firms, it appears that institutions, professional investors with substantial resources, invest in dual class firms and capture the family control premium.
Our analysis indicates that dual class structures provide costs and benefits to the firms. On the cost side, entrepreneurs and their families – as originators of two classes of common equity – bear significant discounts when selling their shares to the public and suffer substantial negative media for holding super-voting shares. On the benefit side, dual class structures yield excess stock returns of nearly 350 basis points per year, suggesting that on average, these structures do not harm outside investors. Overall, the results reveal that investors exhibit substantial concerns over family control rather than dual class structures.
Ronald Anderson is a Professor of Finance at Temple University.
Ezgi Ottolenghi is an Assistant Professor of Finance at Texas Tech University.
David Reeb is the Mr. and Mrs. Lin Jo Yin Professor in Banking and Finance at the National University of Singapore.