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Dual-class shares, external financing needs, and firm performance

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Abstract

Whereas the agency theory predicts that dual-class shares decrease firm performance, the stewardship theory predicts that dual-class shares increase firm performance. The cumulative findings on the performance consequences of dual-class shares have been weak and/or inconclusive. Because endogeneity is a constant challenge in empirical corporate governance studies, this study uses a unique law change in Switzerland as a source of exogenous variation in the fraction of firms with dual-class shares. Controlling for firm fixed effects and time-varying confounders, we find that dual-class shares neither harm nor benefit firm performance on average. However, dual-class shares increase firm performance if the firm requires external finance and dual-class shares decrease firm performance if the firm does not require external finance. External financing needs mitigate the agency costs between controlling and minority shareholders and create a context in which dual-class shares facilitate firm-specific investments instead of private perquisites. The study’s results have both managerial and policy implications.

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Notes

  1. Recently, natural experiments have become an increasingly popular way to identify causal effects in corporate governance studies. Giannetti and Laeven (2008) tested the influence of ownership concentration on firm performance using a Swedish pension reform as a natural experiment. Bebchuk et al. (2010) employed a Delaware Chancery Court ruling as a natural experiment to test the influence of staggered boards on share prices. Duchin et al. (2010) used the board regulations of the Sarbanes–Oxley Act 2002 to estimate the effect of board independence on performance.

  2. The mean firm age of the full sample of listed firms in Switzerland is not statistically different from that of the sample used for the regressions.

  3. If the number of instruments exceeds the number of endogenous variables, tests of over-identifying restrictions (Hansen 1982) can be applied to examine the second condition. This test requires, however, that at least one of the instruments is valid (Larcker and Rusticus 2010). As we have a perfectly identified model, tests for over-identifying restrictions are not possible in our case.

  4. Including additional controls for firm-year observations in which a firm conducted acquisitions (defined as an actual growth rate higher than the 95th percentile) and divestments (defined as an actual growth rate lower than the 5th percentile) would not change our results in any significant way.

  5. Because firms whose largest shareholder is a financial institution are less likely to have dual-class shares (Maury and Pajuste 2011) and because financial investor ownership also tends to affect firm performance beyond its effect on the firm´s equity structure (e.g., Thomsen and Pedersen 2000), we also included a dummy financial investor equaling 1 if the largest shareholder is a widely held bank or financial institution as defined by Faccio and Lang (2002) as control. However, Stata12 dropped the financial investor dummy due to collinearity with our firm fixed effects. The within-firm variation of the financial investor dummy seems not to be large enough.

  6. Subsample analyses do not reveal any non-linearity of the interaction effect. However, as the cases-to-variables ratio is far below 10, the statistical power of the subgroup analyses is low.

  7. The results would not change in any significant way when removing 23 financial firms (179 firm-year observations) from our sample (results are available upon request).

  8. The results are very similar if the disproportionality of voting rights to cash flow rights is measured by the difference between voting and cash flow rights rather than the ratio. This alternative measure is used, e.g., by Claessens et al. (2002) and Maury and Pajuste (2011).

  9. As Chen et al. (2010) use a corporate governance index that is inversely coded with a large value indicating poor corporate governance quality, the interaction effect is in fact negative.

  10. For excellent reviews of the two opposing approaches of executive compensation, we refer to Bebchuk and Fried (2003).

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Acknowledgments

The author would like to thank three anonymous referees, Brian Boyd, Florian Eugster, Will Mitchell, Pei Sung, Alexander Wagner, and the seminar participants at the Strategic Management Society Conference 2011 in Miami, at the WK ORG Workshop 2012 in Berlin, at the VHB Jahrestagung 2013 in Würzburg, and at the Universities of Münster and Konstanz for constructive comments. The usual disclaimer applies.

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Correspondence to Stephan Nüesch.

Appendix

Appendix

Table 8 The largest shareholder’s dual-class shares and firm performance without using the law change as an instrument

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Nüesch, S. Dual-class shares, external financing needs, and firm performance. J Manag Gov 20, 525–551 (2016). https://doi.org/10.1007/s10997-015-9313-5

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