Bucking the Trend: Why do IPOs Choose Controversial Governance Structures and Why Do Investors Let Them

Abstract

While the percentage of mature firms with classified boards or dual class shares has declined by more than 40% since 1990, the percentage of IPO firms with these structures has doubled over this period. We test whether IPO firms implement these structures optimally or whether they are utilized to allow managers to protect their private benefits of control. Both shareholder voting patterns and changes in firm types going public suggest that the Agency Hypothesis best explains IPO firm’s use of dual class, particularly when there is a large voting-cash flow wedge. In contrast, among firms with high information asymmetry, classified board structures are better explained by the Optimal Governance hypothesis.

Keywords: IPOs, governance, dual class, classified board, shareholder voting, founders, carve-outs

JEL Classification: G23, G32, G34