Agency Conflicts, Controlling Owner Proximity, and Firm Value: An Analysis of Dual‐Class Firms in the United States

• DOI: http://doi.org/10.1111/j.1467-8683.2010.00783.x
• Author: Ashok Robin,Chun‐Keung Hoi
• Published date: 01 March 2010
• Date: 01 March 2010

Agency Conf‌licts, Controlling Owner Proximity,

and Firm Value: An Analysis of Dual-Class

Firms in the United States

Chun-Keung Hoi* and Ashok Robin

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: The study seeks to understand whether the proximity of the largest shareholder (controller) to

the locus of management – whether the controller is a top executive, a board member, or an outsider – determines the value

of US dual-class f‌irms.corg_783124..135

Research Findings/Insights: Using a sample of 209 US dual class f‌irms from the year 2000 and a corresponding control

sample of single-class f‌irms, we run cross-sectional regressions to determine the effect of the controller on f‌irm value. We

present robust evidence that dual-class f‌irm value is negatively related to controller proximity. Dual-class structure overall

is unrelated to f‌irm value, because despite its negative effects with high proximity controllers there appear to be benef‌its

when controller proximity is low (when the largest shareholder is an outsider).

Theoretical/Academic Implications: Ownership structure is a widely studied subject but most studies focus on insider

ownership. More nuanced aspects of ownership such as controller proximity are needed in empirical studies and theoretical

models. These nuances could help us better understand the interplay between the incentive of various parties (e.g.,

managers, large shareholders) and the opportunity available for extraction of private benef‌its.

Practitioner/Policy Implications: A practitioner implication is that shareholder of high-proximity dual-class f‌irms must

seek additional control mechanisms to curb agency costs. A policy implication is that investor protection (laws and

institutional structure protecting shareholders) works only to a limited extent – it curbs overt acts of expropriation, but

cannot eliminate acts engineered by insiders.

Keywords: Corporate Governance, Governance Environments, Agency Theory, Shareholder Value, Blockholder

Ownership

INTRODUCTION

Many corporations in the US and around the world

have a dual-class equity structure that assigns

unequal voting rights to holders of different classes of

common stock. A dual-classstructure separates voting rights

from cash f‌low rights and facilitates control. This enables a

dual-class f‌irm’s largest shareholder (hereafter called a

controller-owner1or simply controller) to control it without

making a corresponding capital investment in its equity. The

“wedge” or “divergence” between voting and cash f‌low

rights gives the controller-owner the incentive to pursue

private benef‌its (e.g., Grossman & Hart, 1988). For example,

controller-owners can resist value-enhancing takeovers, or

even expropriate minority shareholders through overt

actions such as tunneling, transfer pricing, asset stripping,

investor dilution, and outright stealing.

Empirical studies have addressed various issues concern-

ing the dual class structure using US as well as non-US

samples. One branch of this literature focuses on f‌irm valu-

ation with an emphasis on whether dual class shares vary in

price compared to otherwise similar single-class shares and

how ownership structure affects this variance. A key result,

initially established using international samples (e.g.,

Nenova, 2003), and more recently conf‌irmed with a US

sample (Gompers, Ishii, & Metrick, 2009) is that dual-class

f‌irm values are related to ownership structure. The wedge

between cash f‌low and voting rights of insiders has been

*Address for correspondence: The Saunders College of Business, Rochester Institute

of Technology, Rochester, NY 14623, USA. Tel: 1-585-475-2718; E-mail: ckhoi@

saunders.rit.edu

124

Corporate Governance: An International Review, 2010, 18(2): 124–135

© 2010 Blackwell Publishing Ltd

doi:10.1111/j.1467-8683.2010.00783.x