Dual Class IPOs, Share Recapitalizations, and Unifications: A Theoretical Analysis

63 Pages Posted: 24 Aug 2006

See all articles by Thomas J. Chemmanur

Thomas J. Chemmanur

Boston College - Carroll School of Management

Yawen Jiao

University of California, Riverside

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We analyze a firm's choice between dual class and single class share structures, either at IPO or subsequently, prior to an SEO. We consider an entrepreneur (incumbent) who obtains both security benefits and private benefits of control, and who wishes to sell equity to outsiders to raise financing to implement his firm's project. The incumbent may be either talented (lower cost of effort, comparative advantage in implementing projects) or untalented: the incumbent's ability is private information, with outsiders observing only a prior probability that he is talented (his reputation). The firm's project may be either long-term (intrinsically more valuable, but showing less signs of success in the short run) or short-term (faster resolution of uncertainty). Thus, under a single class share structure, an incumbent has a greater chance of losing control to potential rivals if he undertakes the long-term project, since outside equity holders may vote for the rival if they believe that the project is not progressing well. A dual class share structure allows the incumbent to have enough votes to prevail against any rival, but may be misused by untalented incumbents to dissipate value by not exerting effort. In equilibrium, the incumbent simultaneously chooses the IPO share structure (dual class or single class), project type (long-term or shortterm), and how much effort to exert. Our results help to explain firms' choices between dual class and single class IPOs and the relative post-IPO operating performance of dual class versus single class IPO firms. We also characterize the situations under which a firm will undergo a share unification or a dual class recapitalization, the announcement effect of these events on the firm's equity, and their effect on its subsequent operating performance. Finally, our model provides testable predictions for the conditions under which firms will include stronger antitakeover provisions in their corporate charters and the relationship between the prevalence of such provisions in a firm's charter and its post-IPO operating performance.

Keywords: Dual Class Shares, Voting Structure, Antitakeover Provisions, Recapitalizations, Unifications

JEL Classification: G32, G34

Suggested Citation

Chemmanur, Thomas J. and Jiao, Yawen, Dual Class IPOs, Share Recapitalizations, and Unifications: A Theoretical Analysis. European Corporate Governance Institute (ECGI) - Finance Research Paper Series, Forthcoming, Available at SSRN: https://ssrn.com/abstract=925236 or http://dx.doi.org/10.2139/ssrn.925236

Thomas J. Chemmanur (Contact Author)

Boston College - Carroll School of Management ( email )

Finance Department, 436 Fulton Hall
Carroll School of Management, Boston College
Chestnut Hill, MA 02467-3808
United States
617-552-3980 (Phone)
617-552-0431 (Fax)

HOME PAGE: http://https://www2.bc.edu/thomas-chemmanur/

Yawen Jiao

University of California, Riverside ( email )

Riverside, CA 92521
United States

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