Incentives vs. Control: An Analysis of U.S. Dual-class companies

Dual-class common stock allows for the separation of voting rights and cash-flow rights across the different classes of equity. We construct a large sample of dual-class firms in the United States and analyze the relationships of insider’s cash-flow rights and voting rights with firm value, performance, and investment behavior. We find that firm value is increasing in the level of cash-flow rights and decreasing in the square of cash flow rights, and is decreasing in the level of voting rights and increasing in the square of voting rights. An identical nonlinear relationship is found for the respective ownership variables with sales growth, capital expenditures, and the combination of R&D and advertising. We conclude that the misalignment of incentives in dual-class firms leads to underinvestment and value destruction. Our evidence is consistent with an entrenchment effect of voting control which leads managers to underinvest in growing the firm and an incentive effect of cash flow ownership which induces managers to pursue more aggressive strategies.