Disproportional Control Rights and the Bonding Role of Debt

Abstract

We examine how firms’ capital structure choices vary with the presence of dual-class ownership and the degree of disproportional control associated with it. We document that, compared to a propensity-matched sample of single-class firms, dual-class firms have higher leverage, greater propensity to issue private debt, more long-term debt, and greater reliance on financial covenants. Within our dual-class sample, the use of debt financing increases with the degree of disproportional control via voting rights or board election rights. This evidence is consistent with controlling insiders bonding against the agency problems associated with dual-class ownership through their capital structure choices. Also consistent with this view, we document that leverage attenuates (and ultimately reverses) the adverse effect of dual-class status on Tobin’s q and cost of equity capital, and is associated with increased institutional investment in dual-class firms. Taken together, our evidence suggests that debt plays a governance role and disciplines insiders in dual-class firms.

Keywords: corporate governance, dual-class ownership, disproportional control, debt financing, capital structure, Tobin’s q

JEL Classification: G30, G38