To Extract or Not to Extract: An Examination of the Dual Class Discount, and the Channels of Extraction of Private Benefits

Abstract

Several recent studies provide evidence that dual class firms are discounted compared to similar single class companies due to the extraction of private benefits and agency costs. However, the channels through which private benefits are extracted have not been fully explored in the literature. With a propensity score matched sample of S&P 1500 dual class and single class companies with concentrated control, this paper investigates the link between the observed valuation discount of dual class companies and three channels through which private benefits can be extracted: excess executive compensation, excess capital expenditure and excess cash holdings. This research provides evidence that excess compensation and excess cash holdings of dual class companies are directly related to the discount that investors apply to the value of dual companies. The findings indicate that excess compensation is paid to executives in dual class companies and the degree of excess compensation is greatest for executives who are family members. The results also show that dual class firms retain more cash compared to single class concentrated control firms. However, capital expenditure is not statistically significant in explaining the dual class discount.

Keywords: Dual Class Discount, Executive Compensation, Cash Holdings, Family Ownership and Control

JEL Classification: G30; G32; G34; J33