Board Characteristics in Dual Class Firms: A Missing Link

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Abstract

The relationship between insider ownership and firm value has been shown to be non-monotonic. While incentive-alignment effects from insider cash flow rights affect performance positively, entrenchment effects from voting rights have a negative impact. We posit that board characteristics are one channel by which insider ownerships affects firm performance. A new hand-collected sample of dual class firms from 2000 to 2012 allows us to separately assess the incentive and entrenchment effects of ownership, which are confounded in single class firms. We find that the wedge between voting rights and cash flow rights, as well as voting rights, are negatively associated with common proxies for board effectiveness, whereas insider cash flow rights display a positive association. Next, we replicate prior findings of a negative association of firm value (Tobin’s Q) with the extent of separation of voting rights from cash flow rights, and conduct mediation analyses. We find robust evidence for a partial mediation, i.e., some, but not all, of the negative effects of a separation of voting rights from cash flow rights on firm performance comes from poor board characteristics, consistent with insiders’ ability to monopolize and capture the board when strong board monitoring is most needed.

Authors

• Lindsay C. Baran, Kent State University

• Arno Forst, Kent State University