Agency Problems at Dual-Class Companies
THE JOURNAL OF FINANCE • VOL. LXIV, NO. 4 • AUGUST 2009
Agency Problems at Dual-Class Companies
RONALD W. MASULIS, CONG WANG, and FEI XIE∗
ABSTRACT
Using a sample of U.S. dual-class companies, we examine how divergence between insider voting and cash f low rights affects managerial extraction of private benefits of control. We find that as this divergence widens, corporate cash holdings are worth less to outside shareholders, CEOs receive higher compensation, managers make shareholder value-destroying acquisitions more often, and capital expenditures contribute less to shareholder value. These findings support the agency hypothesis that managers with greater excess control rights over cash f low rights are more prone to pursue private benefits at shareholders’ expense, and help explain why firm value is decreasing in insider excess control rights.
THE SEPARATION OF OWNERSHIP and control has long been recognized as the source of the agency problem between managers and shareholders at public corporations (Berle and Means (1932), Jensen and Meckling (1976)), and its shareholder-value ramification has been the subject of an extensive literature.1 While most of this research focuses on firms in which voting or control rights and cash f low rights are largely aligned, recently some researchers have started to examine companies with alternative ownership schemes such as cross-holding, pyramidal, and dual-class structures. These alternative ownership arrangements, which are common in much of the world, often result in a significant divergence between insider voting rights and cash f low rights. This divergence aggravates the agency conf licts between managers and shareholders, since insiders controlling disproportionally more voting rights than cash f low rights bear a smaller proportion of the financial consequences of their decisions while
∗ Ronald W. Masulis is from the Owen Graduate School of Management, Vanderbilt University; Cong Wang is from the Faculty
Agency Problems at Dual-Class Companies
RONALD W. MASULIS, CONG WANG, and FEI XIE∗
ABSTRACT
Using a sample of U.S. dual-class companies, we examine how divergence between insider voting and cash f low rights affects managerial extraction of private benefits of control. We find that as this divergence widens, corporate cash holdings are worth less to outside shareholders, CEOs receive higher compensation, managers make shareholder value-destroying acquisitions more often, and capital expenditures contribute less to shareholder value. These findings support the agency hypothesis that managers with greater excess control rights over cash f low rights are more prone to pursue private benefits at shareholders’ expense, and help explain why firm value is decreasing in insider excess control rights.
THE SEPARATION OF OWNERSHIP and control has long been recognized as the source of the agency problem between managers and shareholders at public corporations (Berle and Means (1932), Jensen and Meckling (1976)), and its shareholder-value ramification has been the subject of an extensive literature.1 While most of this research focuses on firms in which voting or control rights and cash f low rights are largely aligned, recently some researchers have started to examine companies with alternative ownership schemes such as cross-holding, pyramidal, and dual-class structures. These alternative ownership arrangements, which are common in much of the world, often result in a significant divergence between insider voting rights and cash f low rights. This divergence aggravates the agency conf licts between managers and shareholders, since insiders controlling disproportionally more voting rights than cash f low rights bear a smaller proportion of the financial consequences of their decisions while
∗ Ronald W. Masulis is from the Owen Graduate School of Management, Vanderbilt University; Cong Wang is from the Faculty