Dual Class IPOs, Share Recapitalizations, and Unifications: A Theoretical Analysis

56 Pages Posted: 25 Mar 2008

See all articles by Thomas J. Chemmanur

Thomas J. Chemmanur

Boston College - Carroll School of Management

Yawen Jiao

University of California, Riverside

Multiple version iconThere are 2 versions of this paper

Date Written: March 2007

Abstract

We analyze a firm's choice between dual class and single class share structures, either at IPO or subsequently, prior to an SEO. We consider an entrepreneur ("incumbent") who obtains both security benefits and private benefits of control, and who wishes to sell equity to outsiders to raise financing to implement his firm's project. The incumbent may be either talented (lower cost of effort, comparative advantage in implementing projects) or untalented: the incumbent's ability is private information, with outsiders observing only a prior probability that he is talented (his "reputation"). The firm's project may be either long-term (intrinsically more valuable, but showing less signs of success in the short run) or short-term (faster resolution of uncertainty). Thus, under a single class share structure, an incumbent (not holding a majority equity stake in the firm) has a greater chance of losing control to potential rivals if he adopts the long-term project, since outside equity holders may vote for the rival if they believe that the project is not progressing well. A dual class share structure allows the incumbent to have enough votes to prevail, but may be misused by untalented incumbents to dissipate value by not exerting effort. In equilibrium, the incumbent simultaneously chooses the IPO share structure (dual class or single class), project type (long-term or short-term), and how much effort to exert. Our results help to explain firm's choices between dual class and single class IPOs and the relative post-IPO operating performance of dual class versus single class IPO firms. We also characterize the situations under which a firm will undergo a share unification or a dual class recapitalization, the announcement effect of these events on the firm's equity, and their effect on its subsequent operating performance.

Keywords: Dual Class Shares, Voting Structure, Antitakeover Provisions, Recapitalizations

JEL Classification: G32, G34

Suggested Citation

Chemmanur, Thomas J. and Jiao, Yawen, Dual Class IPOs, Share Recapitalizations, and Unifications: A Theoretical Analysis (March 2007). Available at SSRN: https://ssrn.com/abstract=1108857 or http://dx.doi.org/10.2139/ssrn.1108857

Thomas J. Chemmanur (Contact Author)

Boston College - Carroll School of Management ( email )

Finance Department, 436 Fulton Hall
Carroll School of Management, Boston College
Chestnut Hill, MA 02467-3808
United States
617-552-3980 (Phone)
617-552-0431 (Fax)

HOME PAGE: http://https://www2.bc.edu/thomas-chemmanur/

Yawen Jiao

University of California, Riverside ( email )

Riverside, CA 92521
United States

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