THE JOURNAL OF FINANCE • VOL. LXIV, NO. 4 • AUGUST 2009
Agency Problems at Dual-Class Companies
RONALD W. MASULIS, CONG WANG, and FEI XIE∗
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 of Business Administration, Chinese University of Hong Kong; and Fei Xie is from the School of Management, George Mason University. We thank Paul Gompers, Joy Ishii, and Andrew Metrick for generously sharing data on dual-class companies. We also thank Cam Harvey (the editor), an anonymous associate editor, an anonymous referee, Harry DeAngelo, Mara Faccio, Wi-Saeng Kim, Michael King, Lily Qiu, Anil Shivdasani, and seminar participants at Chinese University of Hong Kong, City University of Hong Kong, Nanyang Technological University, Peking University, San Diego State University, Vanderbilt University, the 2nd International Conference on Asia-Pacific Financial Markets, the 13th Mitsui Life Symposium on Global Financial Markets, 2007 FMA Annual Meeting, and 2007 European FMA Meeting for valuable comments. Cong Wang also acknowledges the financial support of a Direct Allocation Grant at CUHK (project ID: 2070391, 07-08). 1 Early studies include Demsetz and Lehn (1985), Morck, Shleifer, and Vishny (1988), and McConnell and Servaes (1990). Becht, Bolton, and Roell (2003) and Morck, Wolfenzon, and Yeung (2005) provide comprehensive reviews of the literature.
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having a greater ability to forestall, if not block, changes in corporate control that could threaten their private benefits and continued employment at the company. Consistent with this intuition, Claessens et al. (2002), Lemmon and Lins (2003), Lins (2003), Harvey, Lins, and Roper (2004), and Gompers, Ishii, and Metrick (GIM (2009)) document that firm value and stock returns are lower as corporate insiders control more voting rights relative to cash f low rights. An important question left unaddressed by prior studies relates to the channels through which insider control rights–cash f low rights divergence leads to lower shareholder value. Anecdotal evidence suggests that managerial expropriation of outside shareholders may be at work (see the examples in Johnson et...
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