Insulation by Separation: When Dual-Class Stock Met Corporate Spin-offs
UC Irvine Law Review, Forthcoming
58 Pages Posted: 15 Mar 2019 Last revised: 31 Mar 2019
Date Written: March 5, 2019
The recent rise of shareholder engagement has revamped companies’ corporate governance structures so as to empower shareholder rights and to constrain managerial opportunism. Notwithstanding the general trend, this Article uncovers corporate spin-off transactions — which divide a single company into two or more companies — as a unique mechanism that insulates the management from shareholder intervention. In a spin-off, the company’s managers can fundamentally change the governance arrangements of the new spun-off company without being subject to monitoring mechanisms, such as shareholder approval or market check. Those changes often empower managers over shareholders. Furthermore, most spin-off transactions enjoy tax benefits. The potential agency problems associated with the managers’ unilateral governance changes can be further compounded when the managers adopt multiple classes of common stock with unequal voting rights (“dual-class stock”) in the new spun-off company without shareholder approval.
This is the first Article to systematically examine the problem from both corporate and tax law perspectives and to offer possible solutions. The Article argues that when the managers’ unilateral governance changes are substantial, certain adjustments to corporate and tax laws may be necessary to curb managerial opportunism. For instance, under corporate law, when spin-off transactions accompany a charter amendment, shareholder approval, either at the state law level or company charter level, can be mandated. In addition, tax law can revisit the “continuity of interest” requirement to evaluate whether material changes in shareholder voting rights can disqualify certain spin-offs from tax-free treatment. The Article will also present new insights into the long-standing debate on dual-class stock by showing how the perceived risk of dual-class stock can be magnified when combined with spin-off transactions.
Keywords: Dual-class stock, Spin-off, Corporate reorganization, Tax-free reorganization, Corporate governance, Managerial opportunism, Agency problem, Business judgment rule, Shareholder voting
JEL Classification: K22, K34
Suggested Citation: Suggested Citation