Governance beyond Agency Theory : the Tale of Dual Class Firms

This paper attempts to investigate the theoretical underpinnings for the reasons why firms frequently adopt the dual class equity structure, i.e. a capital (or ownership) structure based on the issuance of shares with differential voting rights (DeAngelo et al. 1985). Such an ownership structure is justified by some researchers as a defensive structure adopted by the directors and managers of a firm to prevent hostile acquisitions and takeovers by corporate raiders (Grossman and Hart, 1988; Harris and Raviv, 1988), and as a means of wealth enhancement of all shareholders (Alchain & Demsetz, 1972; Gromb 1993; Zingales, 1995). Many researchers however, assert that dual class shares are a mechanism by which insiders expropriate value from the minority shareholders, extract private benefits of control and ensure managerial entrenchment (Jarrell and Poulson, 1988; Gompers et al., 2004). The rationale for both of these assertions, as for most corporate governance mechanisms, is based on the principles of agency theory (Shleifer & Vishny, 1997; Becht et al., 2003). However, numerous studies have pointed out inconsistencies in the dual class ownership mechanism that cannot be explained by agency theory (Lease, 1984; DeAngelo and DeAngelo, 2000; Faccio and Lang, 2002). Thus the governance models based solely on the tenets of agency theory based does not seem to suffice in explaining many of the relevant issues of the dual class firms. Understanding the governance issues in ownership structures that enable controlling shareholders voting/control rights significantly in excess of their cash flow rights (and thus the issues of control within ownership), is considered to be of importance as such structures are common in firms globally (La Porta et al, 1999) and are the predominant structure outside of US and UK (Gompers et al., 2004). ost researchers continue to focus on separation of ownership and control for studying governance mechanisms issues of these firms. This paper addresses this gap in literature and looks beyond agency theory to seek alternative rationales specifically for the adoption of dual class ownership structure by firms, with a focus on exploring the theoretical underpinnings of rationales for control issues within ownership.