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Sticking Around Too Long? Dynamics of the Benefits of Dual-Class Structures

Abstract: 

Existing theoretical and empirical research argues that a proportional voting right is universally optimal. Contrary to this view, we find that on average, dual-class firms trade at the same relative valuation (measured by Tobin'sq) as otherwise equivalent single-class firms. However, maturity is a key factor that drives this effect: Young dual-class firms trade at a premium relative to single-class firms. As they become mature, dual-class firms experience a 7%–9% larger decline in valuation and faster deterioration in operating margins and labor productivity. Thus, the net benefits of adopting a dual-class share structure appear to dissipate significantly over firm maturity. The pace of innovation also declines faster for maturing dual-class firms relative to single-class firms. Consistent with increasing private benefits of control with maturity, we find that voting premium and announcement returns for dividend increases are higher for mature dual-class firms. In addition, as dual-class firms mature, their investment and employment become less sensitive toq, and stocks become riskier than those of mature single-class firms. When mature single-class firms switch to become dual-class, market value decreases 4%–5% more than when young single-class firms switch. While 60% of dual class firms have subset provisions, we find that the vast majority of them are ineffective. Overall, the evidence suggests that while dual class may be beneficial for young growth firms, agency costs increase as dual class firms mature and that the usage of dual-class structures should decline over firm maturity. We argue that by using effective sunset provisions conditional on firm age or growth, one can alleviate this problem in a time consistent manner, which should be the focus of regulators and firms, as opposed to banning dual class shares altogether