Thursday, April 27, 2006

Unifying dual-class shares: Part 2

Studies show that this trend towards unification of dual-class shares is motivated by sound reasoning.

Morck et al. (1988) and Shleifer and Vishny (1997) are some of the early papers that found that concentration of control rights (such as in Class A shares, a small proportion of the total shares outstanding) has a negative effect on firm value.
This new working paper confirms these results, adding that separation of voting from cash-flow rights through the use of dual-class shares, pyramiding, and cross-holdings is especially associated with lower market values.

A recent study of unifications by Dr. Anete Pajuste from her study entitled "Determinants and Consequences of the Unification of Dual-class Shares", available here makes the interesting argument that the reasons that once caused the introduction of dual-class shares, i.e., the need to issue new equity and to defend firm from a possible takeover, are the same that now motivate firms to switch back to one share-one vote. Here is the relevant passage from the paper:

.....One of the factors is the change in fashion. In 1984, the New York Stock Exchange (NYSE) undertook a revaluation of its policy (introduced in 1957) not to list companies with dual-class share structure. The discrimination of dual-class shares on NYSE ceased to exist in 1986.3 This step improved the marketability of dual-class shares. The increased reorganizations of corporate voting rights was also common in response to the takeover boom of the 1980s. In recent years, the fashion has arguably changed. In the aftermath of Enron and other corporate governance scandals, anything that can potentially increase the managerial entrenchment becomes suspicious. The popularity of dual-class shares, one of the most obvious and visible tools for increasing managerial (or large shareholder) entrenchment, has been adversely affected. As a result, the companies that need to approach the investors for new capital are the ones that cannot afford to be out of fashion.

Though this fashion-based argument appears to reduce the arguments for and against dual-class shares to a subjective basis, there are certainly compelling value-based reasons to unify, quoted in the same paper.
The results of this study, in fact, provide corroborating evidence to support the earlier studies that concluded that separation of ownership and voting rights reduces firm value, since firm value increases after the unification of the two classes of shares in the companies researched.

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