One Share-One Vote is Unenforceable and Sub-Optimal

Abstract:     
In the presence of derivative markets, shareholders can choose their desired mix of cash flows/votes and vary it through time. We demonstrate that shareholders are better off having the technology that enables the separation of the ownership of voting rights from the ownership of cash flows. Shareholders optimally use synthetic stocks constructed with options as a credible commitment device in control contests. By changing their per vote exposure to cash flows, shareholders reduce the attractiveness of the winning team thereby forcing it to pay them its entire surplus. Our model develops a new empirical estimate of the private benefits of control which is the difference in prices of the stock and the synthetic stock. Interestingly, when the control contest is only a possibility, stockholders optimally choose a 1S1V structure. This ability to deviate from 1S1V when needed increases the value of the firm. Recent empirical evidence indicating increases of volume and open interest of Call and Put options around the announcement of M&A deals is evidence consistent with our theory.

Keywords: corporate governance, regulation, security voting structure, control contests, derivatives

JEL Classifications: G32, G34

Working Paper Series