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Substitutes for voting rights: evidence from dual class recapitalizations.

R. Charles Moyer is Integon Professor of Finance at the Babcock Graduate School of Management, Wake Forest University, Winston-Salem, North Carolina. Ramesh Rao is an Associate Professor of Finance at Wayne State University, Detroit, Michigan. Phillip M. Sisneros is an Assistant Professor of Finance at the University of Houston, Houston, Texas.

The resolution of the agency costs that result from the separation of the decision-making from the risk-bearing functions in the modern corporation is a fundamental concern in finance. Internal and external monitoring activities can help ensure that managers, through their decision management function, act in the interests of shareholders. Principal monitoring mechanisms include the composition and role of the board of directors (Morck, Schleifer and Vishny |23~, Shleifer and Vishny |28~, Fama and Jensen |13~, and Weisbach |32~), the managerial labor market (Fama |12~), voting rights (Manne |21~), the use of incentive contracts (Haugen and Senbet |16~, Harris and Raviv |15~, Baker, Jensen and Murphy |2~, and Miller and Scholes |22~), external monitoring activity by security analysts and institutional investors (Jensen and Meckling |19~, Moyer, Chatfield and Sisneros |24~, Bhushan |3~, and Agrawal and Mandelker |1~), and the capital and product markets (Diamond |9~, Campbell and Kracaw |5~, Watts and Zimmermann |31~, Booth and Smith |4~, and Titman |29~). In addition to these monitoring mechanisms, managers can signal their credible commitment to a value-maximizing strategy by increasing the firm's debt leverage (Jensen |18~, and Harris and Raviv |14~) and/or its dividend payout (Easterbrook |10~).

With a wide range of available monitoring mechanisms, an important policy question is whether the curtailment of shareholder voting rights, through dual class recapitalizations, tends to entrench management, or whether other monitoring mechanisms substitute for traditional shareholder voting rights. If the latter is the case, it is more likely that dual class recapitalizations may be more properly viewed as an efficient contracting system that consolidates voting power in the hands of managers, who, for example, may be in a better position to know the true value of the firm and hence, extract higher premiums in the event of a takeover attempt. Control structures that concentrate shareholder voting rights in the hands of managers may not exacerbate owner-manager agency conflicts if alternative monitoring mechanisms are strengthened. Moyer, Chatfield and Sisneros |24~ find evidence of substitutability among alternative monitoring activities.

This paper documents evidence of the emergence of monitoring substitutes in the context of dual class recapitalizations. We examine whether firms that adopt dual class recapitalizations initiate other actions that provide for strengthened alternative monitoring activity. In addition, we examine the role of external monitoring after the adoption of a dual class voting structure. A sample of 114 firms that announced the adoption of dual equity class voting structures between 1979 and 1987 is used to look for evidence of changes in board of director composition, debt leverage, and dividend policy around the time of a dual class recapitalization. We also examine monitoring by security analysts and institutional investors in the time period surrounding dual class recapitalizations. Although it is not possible to establish a causal relationship between increased external monitoring and the adoption of dual class voting structures, evidence of its existence has important implications for the policy debate regarding the impact of dual class recapitalizations on management entrenchment and shareholder wealth.

I. Wealth Impacts of Dual Class Recapitalizations

Partch |25~, Jarrell and Poulsen |17~, and Cornett and Vetsuypens |6~, have evaluated the wealth effects of dual class recapitalizations. Partch's study of 43 firms recapitalizing during the 1962-1984 period finds a slight positive wealth effect for the overall sample, but the analysis of each firm's residuals leads to the conclusion that the recapitalizations have a nonnegative impact on the wealth of shareholders. Jarrell and Poulsen |17~ identify 94 firms that recapitalized during the 1976 to May 1987 period. Overall, Jarrell and Poulsen find a significant negative impact on the wealth of existing stockholders of 0.82%. When the authors segment the sample, based on whether the recapitalization occurred prior to or after the NYSE's decision to not automatically delist firms adopting a dual class capital structure, they find no significant wealth impact for the firms recapitalizing after the moratorium. However, an analysis of the 28 firms that recapitalized during the last year of the sample period indicates a significant wealth effect of -1.4%. Cornett and Vetsuypens |6~ found mixed evidence of a wealth effect for their sample of 70 firms, but generally their findings suggest abnormal price increases around the announcement of dual class recapitalizations.

The mixed findings associated with these studies of the wealth effects of dual class recapitalizations have been attributed by Jarrell and Poulsen |17~, in part, to differences in insiders' ownership of the firms, which acts as a self-enforcing incentive contract. Those firms with prior insider holdings in the range of 30% to 55% had the most negative market reaction because, they argued, the adoption of dual class recapitalizations by these firms further protected the insiders from potential hostile takeovers. Lehn, Netter and Poulsen |20~ find that firms with greater growth opportunities, lower agency costs and lower tax liabilities are more likely to consolidate control through dual class recapitalizations than through LBOs. They conclude that dual class firms have more promising growth opportunities than LBO firms. The differential growth opportunities facing firms undertaking dual class recapitalizations may explain the varied market reactions to their announcement. Another related reason for these mixed findings is that individual firms are subject to differing levels of internal and external monitoring before and after these recapitalizations.

II. Statement of Hypotheses

As documented by DeAngelo and DeAngelo |7~, dual class recapitalizations effectively result in diminished voting rights of external shareholders (who often receive a superior cash flow claim in return for the loss of voting control) and remove the threat of takeovers as a potential external market disciplining mechanism on incumbent management. This does not mean, however, that dual class recapitalizations are undertaken with the objective of management entrenchment. If alternative monitoring mechanisms are activated around the time of the recapitalization, concern about the management entrenchment consequences of these transactions would be mitigated.

The primary thesis of this paper is that the market for corporate control is only one of several agency control mechanisms. Its diminished role in the case of dual class recapitalizations may be offset by enhancements in alternative agency control mechanisms. Our paper considers five alternative mechanisms: (i) board composition; (ii) dividend policy; (iii) capital structure policy; (iv) external monitoring by security analysts; and (v) monitoring by institutional investors. We seek to determine which, if any, of these alternative monitoring mechanisms are more extensively used after a dual class recapitalization.

A. Board Composition

Voting rights are an important agency control mechanism in two ways. First, voting rights give shareholders the ability to elect the directors, whose responsibility it is to monitor management. Second, voting rights give shareholders access to the market for corporate control as a means of disciplining self-serving or ineffective management actions. For shareholders, access to the market for corporate control is essentially a second line of defense. If internal monitoring is ineffective, then recourse to the market for control becomes important. The existence of outside directors who fulfill their monitoring function can make access (or lack of access) to the market for corporate control less important.(1)

To the extent that the board of directors plays a role in monitoring the performance of management, it is the outside directors who bear the primary burden of this responsibility. Fama and Jensen |13~ argue that outside directors have the incentive to act as monitors of management because of the need to protect their reputations as effective, independent decision-makers. The monitoring role of outside directors becomes more important after a firm adopts a dual class equity structure because of the diminution of noninsider shareholder voting rights. For example, DeAngelo and DeAngelo |7~ found that in dual class firms, the common stock holdings of insiders represent a median of 56.9% of the voting rights, but only 24% of the common stock cash flow claim.

With a large portion of the internal monitoring burden falling on the outside directors, the composition of the board is important. Weisbach |32~ shows that outsider dominated boards are more likely than insider dominated boards to respond to poor performance by replacing the CEO. In addition, the decision by an outsider dominated board to replace a CEO results in small, but significant, increases in the wealth of the firm's shareholders. Weisbach |32~ argues that both of these results are consistent with the conclusion that outside directors monitor the performance of the management team. Warner, Watts and Wruck |30~ find that departures by CEOs following poor performance are influenced by the board and also by large blockholders and competition among top managers. Rosenstein and Wyatt |26~ found that the appointment of outside directors leads to significant, positive, share price reactions.

This discussion implies that, with respect to dual class recapitalizations, the resulting loss of voting rights (and consequently the role of takeovers as a disciplining mechanism) may be mitigated by the board assuming a more prominent role as a monitoring agent. Consistent with these results, the first alternative hypothesis is that dual class recapitalizations are accompanied by an increase in the proportion of outside members on the board.

B. Capital Structure

The capital structure of a firm is another potential substitute monitoring mechanism. Jensen and Meckling |19~ have argued that agency costs of external equity may be reduced by increasing the use of debt leverage. Specifically, they demonstrate that using debt reduces the need for external equity and thus, reduces the scope for management-stockholder conflicts. Jensen |18~ further suggests that the fixed payments associated with increasing the level of debt effectively bond the managers to disgorge the free cash flow of the firm. He also argues that debt can be a more effective substitute than dividends in reducing the agency costs associated with free cash flows. The latter can be rescinded with relatively minor consequence, while nonpayment of debt obligations carries with it the potential loss of control through bankruptcy and reorganization. In addition, the issuance of debt results in external monitoring by bondholders, other lenders, investment bankers, and bond rating services. Debt covenants also ensure that the firm's performance will be monitored periodically by trustees. Moyer, Chatfield and Sisneros |24~ found that the use of financial leverage is associated with fewer analysts following a firm, indicating substitutability between alternative monitoring mechanisms. Accordingly, we hypothesize that dual class recapitalizations are associated with an increase in debt leverage.

C. Dividend Policy

Dividend policy also is a potential substitute agency-cost-controlling mechanism. Easterbrook |10~ argues that increasing dividends raises the probability that additional capital will have to be raised externally on a periodic basis and consequently, the firm will be subject to the intensive monitoring associated with the capital raising process. Easterbrook |10~, therefore, concludes that if managers wish to maximize their human and wealth capital tied to the firm, they will have to act in line with stockholder interests. Rozeff |27~ also provides evidence of a link between dividend policy and agency costs. Jensen |18~, using a different approach, argues that an increase in dividend payout policy effectively "bonds" management to paying this higher level of dividends and consequently reduces management's control over the free cash flow and the motivation to divert these funds to non-optimal uses. This analysis implies that dual class recapitalizations are associated with an increase in the firm's dividend payout ratio.

D. External Monitoring by Analysts and Institutional Stockholders

Changes in the composition of the board of directors, a firm's use of debt leverage, and dividend policy are dictated by management and the board of directors. Other potential monitoring mechanisms, such as the scrutiny provided by security analysts and institutional investors, are not controlled by management, but may still be effective alternatives to reduced direct shareholder voting control.

Jensen and Meckling |19~ argue that external monitoring activity is an important control element when agency conflicts exist. One group of external monitors includes security analysts employed by investment bankers, brokerage firms, and large institutional investors. Moyer, Chatfield and Sisneros |24~ empirically test the hypothesis that the extent of monitoring activity by security analysts is a positive function of the level of agency costs in a firm. Using several independent variables to proxy for various agency cost elements, they find that cross-sectional differences in the number of analysts following a stock is related inversely to insider holdings and the debt ratio, and positively related to growth, size of the firm, number of stockholders, and institutional ownership. Although not a direct test of the substitution hypothesis, these results do show that external monitoring by analysts is greater where the alignment between management and shareholders, through insider ownership claims on the firm's cash flow, is low. Bhushan |3~, using a similar framework, explores the demand for information services using the number of analysts following a stock as a proxy and documents an inverse relationship between analysts following and insider ownership in the firm.

Shleifer and Vishny |28~ and Demsetz |8~, among others, argue that large block shareholders have a strong incentive to monitor managers because of their significant economic stakes. Agrawal and Mandelker |1~ explore this issue with respect to institutional holders and antitakeover charter amendments (ATCA). Specifically, they find support for the "active monitoring" hypothesis of institutions and document a positive relationship between the wealth effects of ATCA proposal announcements and the proportion of equity owned by institutions. Thus, it appears that the potential loss of the takeover mechanism due to ATCA amendments is not a major concern if monitoring by external blockholders, such as institutions, is significant.(2)

Prior research regarding the relationship between dual class recapitalizations and external monitoring by security analysts and institutional investors suggests that (i) dual class recapitalizations will be associated with an increase in external monitoring by security analysts, and (ii) dual class recapitalizations will be associated with an increase in external monitoring by institutional investors in the stock.

E. Prior Insider Ownership

In addition to the tests identified above, we also consider the impact of the level of insider ownership before the dual class recapitalization on changes in each of the alternative monitoring mechanisms. Insider ownership is defined as the number of shares of common stock held by officers and directors divided by the total common shares outstanding at the end of the last full year prior to the recapitalization. The source of the data is Spectrum 6. Following Jarrell and Poulsen |17~, we hypothesize that if the change in the use of a monitoring mechanism is in response to the dual class recapitalization, the change should be greatest for low initial levels of insider ownership. Accordingly, in our tests of the relationship between prior insider ownership and changes in the use of various monitoring mechanisms, we stratify the data by various levels of prior insider ownership. When the initial level of insider ownership (and hence, voting control) is low, a dual class recapitalization greatly increases management's voting control, and consequently the potential for entrenchment. When management already possesses a high level of voting control prior to the recapitalization, further entrenchment is unlikely.

III. Data and Methodology

The empirical tests involve a comparison of mean levels of the variables of interest over the two years before and the two years subsequent to the announcement of the dual voting class recapitalization. In the case of changes in the dividend payout ratio and the debt ratio, we control for market-wide changes in these variables. For these control tests, we use composite, average data from COMPUSTAT for all firms with complete data available for the period 1977 to 1989, exclusive of the 114 firms in our sample and all other firms with identifiable dual class capital structures.(3) In addition to a paired t-test, we also use a nonparametric signed rank test to establish the significance level of the change in a variable.

The sample includes the 114 firms that announced (on a date that could be identified) dual class recapitalizations during the 1979 to 1987 period. Exhibit 1 summarizes the number of recapitalizations by year. Firms included in the sample either had an announcement of the recapitalization appearing in the Wall Street Journal (36 firms), or in an SEC document (78 firms). The announced recapitalizations represent 79 different industries. The average asset size of the firms in the sample was $517.1 million with a range of $5.4 million to $7.7 billion. Thirty-four of the firms were listed on the NYSE, 36 were on the Amex, and 44 traded on NASDAQ at the time of the recapitalization announcement. While the total sample size is 114, the actual number of firms used in each test varies depending on the availability of data used for testing each hypothesis.

IV. Discussion of Results

A. Board of Directors

Information about the composition of the board of directors was obtained from annual issues of Standard & Poor's Register of Corporations, Directors and Executives. For each company, we consulted the S&P Register for information on board members for the second year preceding and the second year following the dual class recapitalization announcement. For example, if a dual recapitalization was announced during 1985, we examined the board structure for 1983 and 1987. Board members are classified as insiders if they are also listed as an officer of the firm according to the S&P Register; otherwise, they are classified as outsiders.(4) Panel A of Exhibit 2 presents information on the board composition for the second year before and after the announcement of the recapitalization. The mean board size increased by nearly one member for our sample of dual class recapitalizations. The mean number of inside board members declined slightly, while the mean number of outside board members increased by nearly one. The mean proportion of outsiders on the board changed from 53.7% to 59.1% over the two years preceding the announcement of the dual class recapitalization to the two years following the announcement. Panel B of Exhibit 2 presents the results of the paired t-test and the signed rank test of the null hypothesis that the mean proportion of outsiders on the board after recapitalization is less than or equal to the proportion before the recapitalization. As the results indicate, both the t-test and the signed rank test statistic reject the null at the five percent level of significance. These results are consistent with dual class recapitalizations being accompanied by an increase in the monitoring authority of the board via a significant increase in the proportion of external board members.
Exhibit 1. Number of Dual Class Recapitalizations in the Sample
by Year
Year Number of Firms
1979 2
1980 5
1981 1
1982 4
1983 13
1984 13
1985 24
1986 41
1987 11
Total 114


Panel C of Exhibit 2 looks at the relationship between insider ownership before the recapitalization and the change in the proportion of outside directors. For prior insider ownership levels up to ten percent, the proportion of outside directors is significantly greater in the low prior TABULAR DATA OMITTED insider ownership groups than in the high prior insider ownership groups. This finding is consistent with the expectations of Jarrell and Poulsen |17~ that markets perceive dual class recapitalizations by low insider ownership firms as having the greatest potential managerial entrenchment impact because the increase in voting control is greatest in these cases. Consequently, managers appear to increase the proportion of outside director representation on the board to mitigate the problem.

B. Capital Structure

The second hypothesis examines debt leverage as a substitute agency conflict control mechanism. Specifically, it is hypothesized that the increase in the agency cost of external equity caused by the loss or reduction in voting rights may be mitigated by an increased use of debt. Debt leverage is defined as the book value of long-term debt divided by total assets, and the data are derived from COMPUSTAT. To obtain a stable measure of debt structure, TABULAR DATA OMITTED we averaged the ratios for two years prior to and after the announced recapitalization.

Panel A of Exhibit 3 provides summary statistics on the debt ratio before and after the announced recapitalization. The mean debt ratio increased by 3.1 percentage points. Panel B reveals that the null hypothesis of no change or a decrease in the debt ratio after a dual class recapitalization is rejected at the five percent level, based both on the paired t-test and signed rank test statistics. The significant test results imply that managers of firms that undertake dual class recapitalizations may use the monitoring associated with increased leverage as an alternative to direct shareholder monitoring.

It is possible, however, that the findings in Panel B of Exhibit 3 simply reflect a market-wide increase in debt ratios during the sample period. Accordingly, we performed the same significance tests after controlling for market-wide changes in debt ratios. Panel C of Exhibit 3 reports these results. Using the paired t-test, the difference remains significant at the five percent level, although the significance level using the signed rank test is reduced appreciably.

Panel D of Exhibit 3 looks at the relationship between insider ownership before the recapitalization and the change in the debt ratio. For prior insider ownership levels up to 7.5%, the change in the debt ratio is significantly greater in the low prior insider ownership groups than in the high prior insider ownership groups. This finding is consistent with the view that managers adjust capital structures in an attempt to mitigate the potential agency problems created by dual class recapitalizations.

C. Dividend Policy

The third hypothesis examines dividend policy as a substitute agency conflict control mechanism. To test this hypothesis, we compared the average dividend payout ratio for the period surrounding the announcement of the dual class recapitalization. Payout ratios can be unstable because of the volatility of earnings. Hence, we averaged the ratios for the two years before and the two years after the announcement year. The payout ratio is defined as the aggregate common stock dividends paid by the firm divided by the aggregate net income to common stockholders before adjusting for extraordinary items. The data are derived from COMPUSTAT. In calculating the ratio, we excluded firms with negative and zero earnings and dividend payout ratios in excess of 100%.

Panel A of Exhibit 4 provides summary information on the payout ratio surrounding the recapitalization event. The mean payout ratio increased only marginally, and, as shown in Panel B, is not significant. In Panel C, we control for market-wide changes in dividend payout ratios. Using the paired t-test, the difference is significant only at the eight percent level. Using the signed rank test, the difference in the payout ratios before and after the recapitalization is significant at the five percent level. Panel D of Exhibit 4 looks at the relationship between insider ownership before the recapitalization and the change in the dividend payout ratio. There is no evidence of a relationship between prior insider ownership percentages and the change in the dividend payout ratio. This result is inconsistent with the view that managers adjust dividend payout ratios in an attempt to mitigate the potential agency problems created by dual class recapitalizations.

Overall, the results in Exhibit 4 provide little support for the hypothesis that managers of firms that initiate dual class recapitalizations use dividend policy as a substitute mechanism for reducing the potential for agency conflict. Because most of the firms in the sample are relatively small, and may have limited (and expensive) access to equity capital markets, it is not surprising that dividend policy changes do not play a more important role as a substitute monitoring mechanism. The results are consistent with Jensen's argument that dividends may not be as effective as debt leverage in controlling agency costs where free cash flow is involved, because the former may be rescinded by management with little personal cost.

D. External Monitoring Agents

The fourth and fifth hypotheses deal with changes in the intensity of activity by security analysts and institutional investors in their role as external monitoring agents following dual class recapitalizations. We examine changes in the number of analysts following the stock and the institutional holdings of the stock in the periods before and after the announcement of dual recapitalizations. The source of analyst data is the Institutional Brokers Estimate System (IBES) database of I/B/E/S, Inc. The IBES database contains earnings estimates gathered from analysts on a monthly basis. The database contains summary information on earnings estimates for various periods (one quarter ahead, two quarters ahead, current fiscal year, next fiscal year, and so on), and also provides information on the number of analysts providing estimates. Because most analyst attention is directed at current fiscal year projections, we use the number of analysts making one-year-ahead earnings forecasts as a proxy for the number of analysts following the stock. We calculated the average number of analysts following the stock over the 13th to the 24th month preceding the month in which the dual recapitalization was announced and also over the corresponding period after the announcement month.

Panel A of Exhibit 5 indicates that the mean number of analysts following the sample of dual class recapitalization stocks was 5.72 before the announcement, and increased to 7.47 in the period after the announcement. Panel B of Exhibit 5 reveals that the increase was statistically significant at the one percent level, based on the parametric and TABULAR DATA OMITTED nonparametric test statistics. In contrast, Panel C of Exhibit 5 indicates that there is no relationship between prior inside ownership levels and the change in the number of analysts following the stock after the dual class recapitalization. This finding does not preclude a conclusion that increases in the number of analysts following a company after a dual class recapitalization occur because of the need for greater monitoring after such a transaction, but it certainly weakens such a conclusion. An alternative explanation for the findings reported in Panel B of Exhibit 5 is TABULAR DATA OMITTED that dual class recapitalizations normally are associated with increases in the number of shares outstanding and trading, and therefore, an increase in the demand for analyst information. A related argument is that the recapitalization event may draw investor attention to these stocks, thereby resulting in a greater demand for analyst information (apart from the need for monitoring). Similarly, the fact that these firms tend to be small, but growing, firms may account for the increase in analyst attention over time.

Finally, we analyzed changes in institutional holdings surrounding the announcement of dual class recapitalizations. Data on the number of institutions holding stock in each sample firm and the proportion of stock held by institutions at the end of the calendar year for the second year preceding and following the announcement year of the recapitalization were gathered from the year-end issues of Standard & Poor's Stock Guide.

Panel A of Exhibit 6 presents the mean and median values before and after the recapitalization announcement. The average number of institutions holding stock of the recapitalized firms was 28.49 before the recapitalization. This figure increased to 52.66 in the two years following the announcement of the recapitalization. In terms of the TABULAR DATA OMITTED proportion of equity held by institutions, the corresponding numbers are 16.83% before and 24.67% after the announcement. Panel B of Exhibit 6 indicates that these differences are statistically significant at the one percent level. However, Panels A and B of Exhibit 7 indicate that the relationship between prior inside ownership levels and the change in the number of institutions holding the stock (and the proportion of stock held by institutions) after the dual class recapitalization is not consistent with the monitoring hypothesis. An alternative explanation for the significant findings in Panel B of Exhibit 6 may be that the firms in the sample tend to be growing firms that may attract increased institutional interest, irrespective of the dual class recapitalization over time, or the dual class capitalization itself may draw attention to the otherwise overlooked stocks of these firms.

V. Conclusions

Our analysis indicates that alternative monitoring mechanisms, both those that are initiated by managers and those arising in the external market, seem to gain importance after a firm has adopted a dual voting class equity structure. Further, our analysis suggests that a causal relationship may exist between dual voting class recapitalizations and changes in board composition and changes in capital structure. The evidence regarding dividend policy changes around dual class recapitalizations is weak. Finally, there is evidence of increased analyst monitoring activity and increased institutional share ownership around the time of dual class recapitalizations. However, these increases do not appear to be motivated by a greater need for monitoring.

Overall, our findings provide interesting insights concerning the rationale for dual class recapitalizations. One potential explanation is that these recapitalizations are undertaken by managers who seek to entrench themselves at the expense of shareholders. An alternative explanation is that dual class recapitalizations constitute an efficient contracting mechanism that may be in the interest of shareholders, because managers who are more aware of the true value of the firm may be able to exact higher takeover premiums in the event of a takeover. Furthermore, managers who are in control of the long-term destiny of the firm may be more willing to invest in firm-specific human capital.

Our results are inconsistent with the first explanation. The emergence of alternative monitoring mechanisms following dual class recapitalizations offsets, to some extent, the potential for managerial entrenchment and shirking arising from increased voting power. The observed relationship between the increasing potential for managerial entrenchment and increases both in outside board membership and the increased use of debt leverage, actions that are under control of managers, is especially persuasive in this regard. If dual class recapitalizations generally are not undertaken with an objective of transferring wealth from shareholders to managers, then the remaining competing explanation is that they are undertaken with an objective of increasing the efficiency of management and to protect shareholders from undervalued takeover attempts.

TABULAR DATA OMITTED

Investors and regulators should be concerned with the effectiveness of monitoring mechanisms rather than the form of these mechanisms. Our analysis suggests that establishing a policy that forbids dual voting class recapitalizations based on a concern for effective monitoring may not be optimal. Rather, emphasis on the sources and effectiveness of alternative monitoring activities that come into play after dual class recapitalizations provides a sounder basis for making policy judgments regarding the desirability of dual voting class recapitalizations. This paper has offered some initial steps in the direction of such considerations.

1In this study, board members are classified as insiders if they are also listed as an officer of the firm according to the S&P Register. Otherwise, they are classified as outsiders.

2Other large blockholders also can serve as monitors of managerial performance. However, in the case of dual class recapitalizations, large blockholders of the nonvoting (or reduced voting) common shares are unlikely to be effective monitors because their large claim on cash flows is not matched with an equally large claim on voting control. Accordingly, we focus our attention on institutional investors who are in more of a position to be vocal in expressing concern regarding managerial performance, and have, in aggregate, more economic muscle than individual large blockholders. The California Public Employees Pension Fund (CALPERS) is one example of the growth in this type of institutional activism.

3Market-wide measures of board composition, analyst monitoring, and institutional investor monitoring are not available. Controlling for prior insider ownership, however, provides an indication of whether the results can reasonably be associated with the dual class recapitalization event, or whether they occurred because of other firm-specific factors, such as the firm's rate of growth, increased market liquidity, and hence, increased interest in the stock after the recapitalization, economy-wide trends, or chance.

4It is possible that the results from the board of directors tests may be sensitive to the definition of inside versus outside directors. We believe the definition chosen here is most consistent with the monitoring hypotheses being tested.

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Title Annotation:Special Issue: Corporate Control
Author:Moyer, R. Charles; Rao, Ramesh; Sisneros, Phillip M.
Publication:Financial Management
Date:Sep 22, 1992
Words:6093
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