Concentrated Ownership and Long-Term Shareholder Value
39 Pages Posted: 17 Jun 2015 Last revised: 26 May 2017
Date Written: February 28, 2017
Corporate ownership structure with a controlling shareholder is widespread around the world. Conventional accounts of concentrated ownership warn against controlling shareholders’ abusive exercise of control and extraction of “private benefits” at the expense of minority shareholders. These accounts, however, are in sharp contrast with the success achieved by many firms with concentrated ownership and the resurgent popularity of dual class structure (which separates voting rights from rights to profits) with uncontested control, as evidenced by Google, Facebook, and many others. This paper attempts to reconcile the empirical evidence with the existing theory by demonstrating how a moderate amount of private benefits of control can actually enhance long-term value by inducing commitment and investment by the controlling shareholder. On the downside, because private benefits of control are less sensitive to firm performance, they can undermine the controlling shareholder’s incentive to maximize firm value. On the upside, because private benefits of control are non-transferrable (they are “private” and illiquid), they create a lock-in effect, making the controlling shareholder more likely to stay with the firm for the long-term and care about the firm’s long-term reputation and performance. The analysis renders a number of implications. For instance, the paper shows that achieving the optimal balance may require a formal separation of voting rights from rights to profits, as is done in a dual class structure. This can explain why certain founders are taking their companies public with a dual class structure even though such structure is considered to be inefficient and leads to lower proceeds from equity sale. It also leads to a normative argument that, instead of a categorical ban, a more nuanced approach towards such mechanisms, such as heightened judicial scrutiny, could be superior.
Keywords: Controlling Shareholder, Private Benefits of Control, Dual Class Stock, Control Sale, Freezeout
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