The Media and Firm Reputation Roles in Corporate Governance Improvements: Lessons from European Dual Class Share Unifications

• Author: Beni Lauterbach,Anete Pajuste
• DOI: http://doi.org/10.1111/corg.12153
• Date: 01 January 2017
• Published date: 01 January 2017

The Media and Firm Reputation Roles in

Corporate Governance Improvements: Lessons

from European Dual Class Share Unif‌ications

Beni Lauterbach*and Anete Pajuste

ABSTRACT

Manuscript Type: Empirical

Research Questions/Issues: Do media pressure and f‌irm reputational concerns propel corporate governance improvements?

Specif‌ically, can they encourage unif‌ications of dual class shares into a single “one share one vote”class?

Research Findings/Insights: Mediacriticism increases thelikelihood of voluntary dual classshare unif‌ications. Firmsmore sen-

sitive to public image are more likely to unify their dual class shares.

Theoretical/Academic Implications: Media plays an important role in corporate governance promotion. Firm reputation is a

valuable asset, sensitive to public opinion and media criticism. Some real f‌irm decisions can be inf‌luenced by f‌irm image and

reputation consid erations.

Practitioner/Pol icy Implications: Firm image, reputation, and public relations activity are valuable. Media is a powerful and

f‌lexible tool that in some cases can substitute regulation in effectively restraining f‌irms and their controlling shareholders.

Keywords: Corporate Governance, Dual Class Shares, Firm Reputation, Media Impact

INTRODUCTION

In recent years, academic and public interest in corporate

governancehas increased dramatically.New laws and stan-

dards havebeen enacted all over the world (e.g.,the Sarbanes-

Oxley and Dodd-Frank Acts in the US,and the OECD Code of

Best Corporate Governance Practices). Companies faced a

steady if not mounting pressure to improve their corporate

governance. The ultimate goal of this public movement is to

assure that corporations act as “good citizens”,caringfor

and contributing to the rest of society. Special emphasis is

placed on corporateleadership (top management andcontrol-

ling shareholders), requiringthat it would not exploit its obvi-

ous power and would treat fairly its partners, i.e., the small

public shareholders.

In this paper we deal with one corporate governance prob-

lem and the ongoing struggle for its resolution. We focus on

dual class shares. Firms adopting the dual class equity struc-

ture offer two sorts of common shares: superior and inferior

voting power shares. The inferior vote shares usually receive

the same dividends per share as the superior voting shares.

Yet, they are non-voting or have lower voting rights (e.g.,

ten shares are required for one vote).

Typically, the controlling owner, family, or coalition, holds

primarily superior vote shares, while the public hoards the

cheaper inferior vote shares. (This holding structure allows

the control group to secure control at the lowest cost.) Conse-

quently, a wedge is generated, as controlling shareholders’

proportion of voting rights exceedstheir proportion in equity.

Bebchuk, Kraakman, and Triantis (2000) criticize sharply

these “wedge”equity structures, on the ground that this

wedge encourages the control group to further exploit public

shareholders and increase its private benef‌its consumption.

Bebchuk et al. (2000) describe wedge structures as the worst

form of corporate governance. Some conf‌irmatory evidence

is offered by Bennedsen and Nielsen (2010) who document

that the dual class structure signif‌icantlydecreases the market

value of the f‌irm.

The severe potential agency problems present in dual class

share f‌irms can be resolved via dual class share unif‌ication.

In a dual class unif‌ication,all company shares aretransformed

into “one share one vote”.Unif‌ications not only eliminate the

wedge between vote and ownership, they also dilute the vot-

ing power of controlling shareholders (whose superior vote

shares lose their excess voting rights).

In this study, we examine voluntary (f‌irm-initiated) dual

class share unif‌ications in Europe. Previous studies (e.g.,

Maury & Pajuste, 2011) establish that an important motive in

many voluntary unif‌ications is f‌irm’s desire to improve its

public image ahead of a seasoned equity offering. (Over 40

*Address for correspondence: Beni Lauterbach, School of Business Administration,

Bar-Ilan University, Ramat Gan 52900, Israel. Tel: 972 3 5318901; Fax: 972 37384040;

E-mail: beni.lauterbach@biu.ac.il

© 2015 JohnWiley & Sons Ltd

doi:10.1111/corg.12153

4

Corporate Governance: An International Review, 2017, 25(1): 4–19

percent of unifying f‌irms issued equity after the unif‌ication.)

We further explore andexpand this image-improving motive,

relying on the premise that public reputation is one of the

f‌irm’s key assets (see Dyck, Volchkova, & Zingales, 2008). A

unif‌ication increases f‌irm’s reputation by eliminating theneg-

ative image of its dualclass share structure (see Bennedsen &

Nielsen, 2010, forevidence on the heavy market discount,i.e.,

lower Tobin’s Q of dual class f‌irms).

Our f‌irst proposedhypothesis is that when media sentiment

towards dual classshares becomes more negative,the reputa-

tion toll levied upon dual class f‌irms increases (dual class

f‌irms’valuation-discount deepens), and the trend of unif‌ica-

tions intensif‌ies. Consistent with this hypothesis, we identify

positive correlations between the mediaanti-dual class shares

sentiment, dual class f‌irms’valuation discount, and the pro-

pensity of dual class f‌irms to unify. This evidence leads us to

conclude that media pressure helps convince controlling

shareholders to abandon the dual class structure.

Our second testable hypothesis is cross-sectional. We pro-

pose that f‌irms that are more sensitive to their public image

and reputationare more likely to unify their dualclass shares.

The empirical tests support this hypothesis. We f‌ind that on

the eve of a seasoned equity offering (a period of high reputa-

tional concerns),f‌irms are more likely to unify their dual class

shares, and we present evidence suggesting that f‌irms in

industries that are more sensitive to public image exhibit a

higher unif‌ication propensity. Apparently, reputation is a

key consideration of the f‌irm, and it affects f‌irm’sdecisions

and value.

FIRM REPUTATION, THE MEDIA, AND DUAL

CLASS SHARE UNIFICATIONS

Dual Class Shares and Unif‌ications

A nontrivial minority of publicly traded f‌irms around the

world have a dual c lass equity struc ture, namely offer ing

two classes of common shares that differ in their voting

rights, namely superior and inferior vote shares. The dual

class structure, o r more precisely offeri ng inferior vote

shares to the public, has some clear advantages at the initial

fast-growth stages of a f‌irm’s life cycle, where entre pre-

neurs’uninterrupted leadership is important for the f‌irm’s

success (see, e.g., recent IPOs of inferior vote shares by

Google, Facebook, and Groupon). Accordingly, studies

such as Bauguess, Slovin, and Sushka (2007) and Dimitrov

and Jain (2006) record positive stock price reactions to dual

class share capita lizations.

However, upon f‌irm maturity, the unpleasant face of the

dual class structure is exposed. The dual class structure typi-

cally results in a wedge between controlling shareholders’

control (= voting) and equity (= dividend) rights. Rationally,

controlling shareholders concentrate their holdings in supe-

rior vote shares because such a concentration affords them to

secure their rule over the f‌irm at the lowest possible own in-

vestment. (On the otherside, small public shareholders prefer

inferior vote shares that sometimes even offer higher divi-

dends than the superior vote shares.) Consequently, “wedge”

companies, where controlling shareholders’proportion in

f‌irm’s vote exceeds their equity proportion, emerge. These

wedge structures are, in the view of Bebchuk et al. (2000),

the worst form of corporate governance, as they exacerbate

all controlling shareholders’agency problems. With a rela-

tively low equity proportion, the cost to a controlling share-

holderofa$1privatebenef‌its consumption is reduced or

becomes relatively low; hence the controlling shareholder is

tempted to consume more private benef‌its at the expense of

public shareholders.

In a rational world, the disadvantage of mature dual class

f‌irms is widely recognized and appropriatelypriced by public

investors. In Europe, Bennedsen and Nielsen(2010) show that

the dual classstructure discounts f‌irm marketvalue by 25 per-

cent on average, a deeper discount than thataffected by alter-

native structures (e.g., pyramids) that also generate

disproportionate vote and equity holdings.

The negative investor attitude towards mature dual class

f‌irms transpires also in the diff‌iculty these f‌irms have in

raising additional equity. This drove many mature dual class

f‌irms to voluntary abandon their dual class structure. Maury

and Pajuste (2011) show that when future growth opportu-

nities are attractive, it would be worthwhile for some con-

trolling shareholders to give up the extra private benef‌its

afforded by the dual class structure, in return for the abun-

dant extra cash f‌lows promised by the attractive investment

opportunity.

The “external f‌inancing”motive appears relevant and im-

portant in explaining voluntary decisions of f‌irms to unify

their dual class shares. Maury and Pajuste (2011) report that

about 41 percent of the unifying f‌irms issued equity follow-

ing the unif‌ication. (Other f‌irms might have conceived ex-

ternal f‌inancing as well.) Nevertheless, we believe that the

fundamental factor behind the external f‌inancing motive is

public image, and it deserves more explicit discussion. In

our opinion, negative public image and media pressure are

key elements, and they can drive some f‌irms to unify their

dual class shares, even in the absence of external f‌inancing

needs.

1

The idea that f‌irm’s image considerations impact the deci-

sion to unify has been brief‌ly mentioned before (Hauser &

Lauterbach, 2004). However, we are the f‌irst to specif‌ically ar-

ticulate, discuss,and test it along with examining media pres-

sure and media impact on the unif‌ication process.

Firm Reputation

One of the basicassets of a f‌irm is its public image or morepre-

cisely its reputation vis-à-vis the business community with

which it regularly interacts (Dyck et al., 2008). The premise is

that reputation affects valuation. Good reputation promotes

f‌irm prof‌itabilityand business success, hence contributes pos-

itively to share price. In contrast, bad reputation and public

image (due to poor corporate governance, for example)

weaken businesses and discount their share prices.

The reputation premise is consistent with reality. In

practice, the value of reputation is widely recognized.

Consumer-goods f‌irms invest in branding their products,

service f‌irms strive to be associated with adjectives such as

“modern”and “friendly,”f‌inancial institutions aspire to be-

come solid and safe, and all f‌irms seek the labels of “honest”

and “reliable.”

5MEDIA AND FIRM REPUTATION ROLES IN CG IMPROVEMENT

© 2015 JohnWiley & Sons Ltd Volume 25 Number 1 January 2017