Does Diversification of Share Classes Increase Firm Value?

Abstract

Firms can issue stocks classified in many ways. They can be classified in respect to voting rights, dividend rights, redemption rights, conversion rights, and many others. In this study, we ask if it is desirable to give greater freedom to firms in their choices of class shares. Making use of the 2011 Commercial Act amendment that significantly relaxed the regulation on class shares in Korea, we study the motivation and the effect of adopting two newly emerged class shares – preferred stocks convertible to voting stocks at the discretion of management and preferred stocks redeemable at the discretion of investors. We find that firms adopt the former for managerial entrenchment purpose and destroy firm value by doing so. As for the latter, we find that firms adopt them in times of financial distress but fail to stop the downfall in firm value by doing so.

Keywords: share classes, convertible preferred stocks, redeemable preferred stocks, entrenchment, financial distress

JEL Classification: G30, G32, G33, G34