Joumai oJ Business Finance & Accounting, 23(5) & (6), July 1996, 0306-686X

OWNERSHIP STRUCTURE AND MANAGERIAL INCENTIVES: THE EVIDENCE FROM ACQUISITIONS BY DUAL CLASS FIRMS
ROBERT C . HANSON AND M O O N H . SONG*

INTRODUCTION

The large number of ducd class recapitalizations during the 1980s has energized the debate regarding the merits of dual classes of common stock. Eighty-five firms recapitalized during the 1980s in contrast with only three firms throughout the 1970s, and five during the 1960s.' Why managers propose the recapitalization in the first place, and whether a second class of stock with differenticd voting rights helps resolve or actually aggravates agency conflicts remains in doubt. Multiple classes of common stock by themselves are not the issue. Rather, concern centers on disparate voting rights and the ability of incumbent management to gain voting control of the firm without owning a majority ofthe firm's common stock. Furthermore, separating voting rights from residual cash flow claims alters the incentives that managers derive from stock ownership. By not bearing the wealth consequences of their decisions in proportion to their ownership of votes, managers could more easily pursue objectives that benefit themselves at the expense of outside shareholders. Research regarding the impact of dual class recapitalization announcements on shareholder weedth provides ambiguous evidence about the purported benefits or costs of this change in ownership structure.^ Partch (1987) and Ang and Megginson (1989) find positive announcement period returns consistent with DeAngelo and DeAngelo (1985) who argue that focused control creates benefits by encouraging managers to invest in firm specific human capital, and by protecting implicit deferred compensation and bargained-for perquisites. Alternatively, Jog and Riding(1986), Gordon (1988), and Jarrell and Poulsen (1988) find negative announcement period returns. Negative returns are consistent with Gordon (1988), Ruback (1988), and Seligman (1986) who suggest that facing collective action and strategic choice problems, shareholders
* The authors are from the Department of Finance, San Diego State University. They especially appreciate useful comments from Anup Agrawal, Sanjai Bhagat, Saeyoung Chang, Tony Cherin, Dave Ely, Ed Omberg, Sang Park, and the anonymous referee. They also acknowledge useful comments from fmance workshop participants at San Diego State University, University of California-Riverside, University of Houston, and session participants at the 1993 Financial Management Association annual meetings. (Paper received April 1994, revised and accepted July 1994) Address for correspondence: Moon H. Song, Department of Finance, College of Business Administration, San Diego State University, San Diego, CA 92182-8236, USA. Blackwell Publishers Ltd. 1996, 108 Cowley Road, Oxford OX4 IJF, UK and 238 Main Street, Cambridge, MA 02142, USA. 831

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are coerced into granting managers voting control of the company. The dual class recapitalization allows managers to expropriate the value of control from outside shareholders without fair compensation. In addition, focused control creates costs by isolating managers from the disciplining effects of the market for corporate control. This study examines stock returns surrounding acquisitions announced by dual class firms to address whether two classes of common stock with differential voting rights alter managerial incentives. Managerial stock ownership may serve to align managers' incentives with outside shareholder objectives or can serve to entrench managers from the market for corporate control, and will influence the firm's investment decisions. We investigate the incentive effects of stock ownership in dual class firms where managers can concentrate ownership on voting rights. Furthermore, by examining the shareholder wealth effects of acquisitions we avoid the confounding effects present at the initial recapitalization announcement. We investigate whether dual class firms made value decreasing acquisitions and whether the wealth effect varies between share classes. We relate stock returns surrounding announcements of acquisitions to managers' inclination to own shares with superior voting rights, a measure of their preference for control. We analyze whether dual class firm managers engage in unrelated acquisitions to diversify their investment in human capital. Fincdly, we compare dual class firm results with a control sample of single class acquiring firms to determine whether high managerial ownership coupled with disparate voting rights align managers' and shareholders' interests in acquisitions.

HYPOTHESES High levels of managerial ownership will normally allay many agency problems, but in dual class firms the divergence of voting rights from residual cash flow claims alters the incentives derived from stock ownership. Having voting control of the firm, and protected from premature dismissal, managers may pursue strategies that benefit themselves but harm outside shareholders. Acquiring other firms, or divisions of other firms, is one possible strategy. The wealth impact of this strategy will vary across firms and will depend on the incentives provided by managerial ownership structure. The following hypotheses relate the wealth effects of acquisition announcements with managerial ownership structure.
Acquisition Wealth Effects

When acquiring other firms through mergers or tender offers, or acquiring divisions of other firms through interfirm asset sales, managers could be pursuing their own objectives which may harm outside shareholders, or they
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could be following a strategy which maximizes shareholder wejilth. Firm value will decline when managers pursue their own objectives (Morck, Shleifer, and Vishny, 1990) and acquire assets to diversify employment risk (Amihud and Lev, 1981), or to increase corporate wealth (Donaldson, 1984), or that waste free cash flow (Jensen, 1986), or that are manager specific (Shleifer and Vishny, 1989). Shareholders wUl also suffer if managers overpay because of hubris (Roll, 1986), or engage in myopic signalling (Stein, 1988). These activities should be more prevalent in dual class firms that shield managers from the market for corporate control and permit managers greater latitude to follow one of these value reducing strategies. Thus, the acquisition wealth effect hypothesis becomes: Hj: Acquisitions, especially by dual class firms, will reduce firm value and harm shareholders. Alternatively, if managers are following a wealth maximizing strategy, then the acquisition will increase firm value by providing synergy benefits such as improved efficiency, complementary resources, more market power, or by using resources that otherwise would be wasted (Weston, Chung, and Hoag, 1990). In dual class firms, following DeAngelo and DeAngelo (1985), these benefits will be enhanced because managers with voting control ofthe firm make greater investments in firm specific human capitcil. While the acquisition will create value, the acquiring firm may not receive all the gains if they are competed away by rival bidders (Bradley, Desai and Kim, 1988) or negotiated away by target firm managers with relatively more bargaining power (Stulz, Walkling and Song, 1990).
Takeover Premium, Ownership Structure, and Dual Class Acquisitions

To investigate whether allowing managers to separate their ownership of voting rights from residual cash flow claims alters the effectiveness of stock ownership to align managerial incentives with outside shareholder interests, we examine announcement period abnormal returns to each class of stock and total returns. Since an acquisition may affect the likelihood of a takeover attempt and the value of voting rights, abnormal returns should vary across stock classes. Moreover, increased ownership by managers of cash flow claims further aligns their interest with the interests of outside shareholders Qensen and Meckling, 1976). On the other hand, increased ownership of voting rights further entrench managers and could lead to the inefficient allocation of resources (Fama and Jensen, 1983). Thus, the wealth impact of the acquisition will depend on managerial ownership structure. Takeover Premium Hypothesis When managers of dual class firms follow their own objectives, firm value will decrease when they make acquisitions. But the wealth effect will likely differ
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between the classes of stock. Research suggests that shares with superior voting rights, high-vote shares, will sell at a premium to shares with inferior voting rights, low-vote shares, reflecting the value ofthe additional voting power (Stulz, 1988).^ The premium derives from the prospect of receiving a higher payoff if a change in control occurs. Consistent with this notion, DeAngelo and DeAngelo (1985) examined four dual class firms that were acquired and found a control premium in high-vote shares which ranged from 83% to 200%. Megginson (1990) found that in 37 of 43 cases holders of superior voting shares in British dual class firms received a tender offer premium of 27.6% when the firm was acquired. However, when a dual class firm makes an acquisition and in the process makes itself a less attractive takeover target, returns to highvote shares should be lower than returns on low-vote shares. Acquisitions that increase firm size (Palepu, 1986) or that are manager specific (Shleifer and Vishny, 1989), for example, will lower the likelihood of becoming a takeover target. Lower returns reflect a reduced takeover premium in high-vote shares and the further entrenchment of management. Thus, the takeover premium hypothesis becomes: H2: Acquisitions by dual class flrms produce returns to high-vote shares lower than returns to low-vote shares.

Ownership Structure Hypotheses Managers overly interested in controlling corporate resources who place a higher value on control than on residual cash flow claims will choose to increase their ownership of those shares with superior voting rights. The tilt in stock ownership toward shares with superior voting rights allows managers to accumulate votes and consolidate voting control without vast commitments of wealth. The tilt toward voting rights strengthens managers' control ofthe flrm and means that they will suffer less relative to their ownership of votes when they make value reducing acquisitions. When the preference for control is strong, managers may even undertake value reducing acquisitions if the increased value to incumbency more than offsets their pecuniary loss. For example, the added value a manager receives from more prestige, more perquisites, and more job security exceeds the manager's proportional wealth loss suffered on the firm's shares. Thus, the first ownership structure hypothesis becomes: H3: Abornal returns surrounding acquisition announcements are negatively related to the mcinager's preference for shares with superior voting rights. Alternately, DeAngelo and DeAngelo (1985) suggest that focused voting control provides managers the job security that they need to invest in firm specific human capital without fear that they will be replaced with a competing management team. Focused control prevents opportunistic outside shareholders from appropriating managers' returns by unfairly breaking implicit contracts
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for deferred compensation. Protected from premature dismissal, managers are more likely to engage in projects with distant payoffs, especially where their own payoff occurs in the future. A long-term perspective along with larger investments in human capital lead managers to make more valuable acquisitions which are better managed and more profitable under them than the best alternate management team. Under this ilternate view, acquisitions will increase firm value, and the increase will be positively related to the managers' preference for votes. When vote ownership entrenches managers, the job security that arises from voting control allows managers to expropriate the value of control. Entrenched managers will follow their own objectives and make self-serving low value or value reducing acquisitions at the expense of outside shareholders. As in Morck, Shleifer, and Vishny (1990), for example, managers could overpay when making acquisitions with large private benefits or, as in Amihud and Lev (1981), when they acquire assets that diversify their employment risk. Thus, a second ownership structure hypothesis emerges: H4: Managers with a strong preference for shares with superior voting rights make unrelated acquisitions to diversify their employment risk.
Control Sample Comparison

As a final look at how dual classes of stock with differential voting rights alter the incentives of managers when they make acquisitions, we compare acquisitions by dual class firms with acquisitions by single class firms. If voting control entrenches managers, and differentitd voting rights weaken managers' burden of value reducing decisions, then managerial ownership in dual class firms will be less effective for aligning manager and shareholder interests than in single class firms. The more highly managers value the control of corporate resources and tilt ownership toward shares with superior voting rights, the less likely stock ownership will control agency conflicts in comparison to managers of single class firms. We hypothesize that in dual class firms, higher levels of ownership produce deeper entrenchment rather than better alignment of incentives.

DATA AND EMPIRICAL METHODS

A sample of dual class firms was identified by examining the Center for Research on Security Prices (CRSP) 1990 NYSE/AMEX and NASDAQ, files for firms with two classes of stock trading concurrently. Voting rights and dividends for each class were determined from proxy statements or various editions oi Moody's Manuals. This initial search identified 98 firms, excluding limited partnerships and General Motors' class E and H shares, with disparate voting rights. For each firm the Wall Street Journal Index was examined through 1990 to identify
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if the firm acquired another firm through merger or tender offer, acquired a toe-hold position in another firm, or acquired divested assets of other firms through interfirm asset purchases. The search identified 49 firms making 191 acquisitions. Stock ownership by mcinagement (officers and directors as a group) were obtained from proxy statements. We use the proxy statement for the year before the acquisition announcement, or if not available the nearest year. As indicated in Table 1, the final sample for which CRSP daily returns are available consists of 45 dual class firms making 167 acquisitions during 19641990. Proxy data are available for 33 firms making 75 acquisitions over 19781990, while CRSP returns are available for 31 of these firms making 69 acquisitions. The control sample of single class bidders consists of mergers during 1981 through 1990 listed in W.T. Grimm Mergersat Review and reported in the Wall Street Journal Index, and acquisitions first reported on the Wall Street Journal front page during April 1977 through December 1986. Managerial ownership data from proxy statements or Value Line were available for 601 announcements. As shown in Table 1, the market value of equity for the full control sample acquiring firms is $3,388 million on average (median = $1,333 million), while dual class firms average $688 million (median = $430 million). By comparison, the average equity value for all CRSP NYSE/AMEX firms in 1988 was about $900 million. Dual class acquirers are small when compared to the typical acquiring firm. To control for size related effects, we select a sample of 69 acquisitions, from the 601 announcements, matched to dual class firms by

Table 1 Sample Characteristics of Dual Class and Single Class Control Sample Acquiring Firms Dual Class Sampte Full Managerial Ownership (%) High-vote mean shares median mean Low-vote shares median mean All shares median (both classes) mean All votes (both classes) median mean Equity Value median (millions) Number of Acquisitions
Proxy Single Class Sample Full

Matched

$924 $273 167

52.8 55.5 28.3 28.5 36.0 36.7 48.6 47.4 $688 $430 69

7.8 3.0 7.8 3.0 $3,388 $1,333 601

11.6 6.0 11.6 6.0 $693 $437 69

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market value of equity. The matched control sample equity averages $693 million (median = $437 million) versus $688 million (median = $430 million) for the dual class firms.'* Shareholder wealth effects at the announcement of acquisitions are determined using standard event study methods. Abnormal returns are computed from the market model using Scholes and Williams (1977) betas estimated over a 301-day period ending on day 100 relative to the announcement. CRSP equally-weighted NYSE/AMEX and NASDAQ.indices are used as the market index. The Wall Street Journal publication date of the acquisition announcement is event day / = 0. Wealth effects are measured over an eleven-day interval, event days 5 to +5, similar to other studies of returns to acquiring firms.^ Total return is the value-weighted average of returns to each class of stock. Tests of statistical significance avoid the problems associated with event induced increases in variance by forming test-statistics using contemporaneous cross-sectional standard errors. Brown and Warner (1985) and Boehmer, Musumeci, and Poulsen (1991) discuss this issue. Stock ownership by officers and directors as a group provides a measure of the vjdue of control. Typically, insiders own shares of both classes of stock. To the extent insiders place a high value on control, their ownership will tilt toward shares with superior voting rights, or high-vote shares. Indeed, as shown in Table 1, officers and directors as a group own 52.8% ofthe high-vote shares and 28.3% of the low-vote shares. The relative ownership mixes of vote and cash flow claims provide an indication of how strongly managers desire control over residual cash flow. We model the value of control as the ratio ofthe voting claims held by management to their residual cash flow claims. This ratio is: Value of control = Voting Rights/Cash Flow Rights or VC = VR/CR where VR = [c^HighVHigh + CL w VLow]/lVHigh + VL<, ] ^o CR = [ttHigh NHigh + "Low NLo]/[NHigh +
NLO],

(1) (2) (3)

and where VC is the value of control, VR measures the voting rights controlled by management, CR are the cash flow rights controlled by management, a is the fraction of high- or low-vote shares owned by management, V is the total number of votes resident in the high- or low-vote shares, and N is the number of high- or low-vote shares outstanding. Higher values of VC, implying more deviation of voting rights from cash flow claims, suggest that managers place more value on control than cash flow claims'. For sample firms with proxy data, managers and officers as a group control on average nearly half of the total votes, VR = 0.486 (median = 0.474), while owning slightly more than a third of all shares, CR = 0.360 (median
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= 0.367). On average our measure of the value of control indicates that managers prefer voting claims to cash flow claims by an eight-to-five margin, VC = 1.68 (median = 1.35). We interpret values of VC above the median as indicating that managers strongly prefer control to residucd cash flow claims. Ownership levels reported in Table 1 are lower than levels reported in previous studies, e.g., Partch (1987), because our sample contains many NYSE listed firms that recapitalized after June 1984 when the exchange imposed a moratorium on delisting dual class firms. For similar reasons, the value of equity reported in Table 1 is much larger than values reported in previous studies where many dual-class firms were small over-the-counter traded companies. Managers of control sample firms own on average 7.8% (median = 3.0%) of their firm's stock for the full control sample and they own on average 11.6% (median = 6.0%) ofthe shares for the size-matched control sample. This is less than the ownership by dual class firm managers, who own on average 36.0% (median = 36.7%) of their firm's shares. Ownership for the matched control group ranges from 0% to 45%, while for dual class firms ownership ranges from 3 % to 82 %. The size and ownership disparity between the control sample and dual class firms is consistent with the negative relation between firm size and managerial ownership found by Demsetz and Lehn (1985) and Mikkelson and Partch (1989).

EMPIRICAL ANALYSIS

To address whether two classes of common stock with differential voting rights alter managerial incentives, we first examine the wealth effects of acquisitions. Then we relate the wealth impact to managerial ownership structure. We investigate the manager's preference for control by relating how returns vary with the value of control (VC) defined in equation (1). We investigate, in effect, whether the ability of managers to choose between voting claims and cash flow claims alters the way their stock ownership controls agency problems.
Analysis of Changes in Shareholder Wealth

Table 2 shows that for both the full sample and the proxy data sample median announcement period returns are negative but close to zero. Only for highvote shares do the Wilcoxon signed rank tests indicate a median significantly different from zero. Furthermore, binomial tests indicate that significantly more than half (59.9% ofthe full sample and 62.3% ofthe proxy sample) ofthe returns are negative. Mean returns are statistically indistinguishable from zero. Control sample abnormal returns are significantly negative for both samples. Matched control sample abnormal returns are 0.017 (median = 0.015) with 39.9% of the returns positive. Negative returns indicate that outside shareholders do not benefit from the acquisitions. Negative returns provide
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Table 2 Abnormal Returns Surrounding Acquisition Announcements

Dual Class Sample Full Proxy Control Sample Full Matched

High-vote shares Low-vote shares Difference (high-low) Total Return

mean median mean median mean median mean median

-0.0012 -0.0104" 0.0058 -0.0046 -0.0070" - 0.0060* 0.0033 -0.0064 167

-0.0097 -0.0120** 0.0028 -0.0060 -0.0125" -O.OIOO** -0.0007 -0.0096 69

-0.0100" -0.0080 601

-0.0170" -0.0150 69

Notes:

Differences are matched pair-wise differences between high- and low-vote shares. Asterisks indicate that means (<-tests) or medians (Wilcoxon signed rank test) are significantly different from zero at the five percent level ( " ) or ten percent level (*).

weak support for the acquisition wealth effects hypothesis (Hi) which suggests that managers pursue their own objectives and make value reducing acquisitions. Returns reported in Table 2 are consistent with bidder returns reported by Bradley, Desai and Kim (1988), Jarrell, Brickley, and Netter (1988), Morck, et al. (1990), and returns to buying firms in interfirm asset sales documented by Hite, Owers, and Rogers (1987), Sicherman and Pettway (1987), and Jain (1985), among others.^
Analysis of Shareholder Wealth and Ownership Structure

Takeover Premium The takeover premium hypothesis (Hj) suggests that returns to high-vote shares should be lower than returns to low-vote shares if an acquisition reduces the likelihood ofa takeover attempt. Consistent with H2, returns to high-vote shares, shown in Table 2, for both the full sample and the proxy sample, are significantly lower than returns to low-vote shares. Wilcoxon signed rank tests and /-tests show that the pair-wise differences between high-vote and low-vote share returns are signifiant at the 5 % level for both the full sample and the proxy sample. High-vote shareholders (52.8% of which are managers) seem to suffer significantly more than shareholders oflow-vote stock (only 28.3% of which are managers) at the announcement of acquisitions. On the surface, managers seem to be making decisions that have a disproportionate negative effect on their own wealth. But when managers derive utility from both wealth and control (Stein, 1988), negative returns could be consistent with managers
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following their own utility maximizing strategy as long as the utility increase associated with control at least offsets the utility decline from lower stock values. To further investigate the takeover premium hypothesis we examine the ratio of the prices of the high-vote and low-vote shares (PHigh/PLow) surrounding the acquisition announcement. Ifthe acquisitions examined in this study lower the probability that outside high-vote shareholders will receive a premium for their shares, then the control premium should be lower after the acquisition. Table 3 reports the results of this analysis for the 37 cases where both classes of stock have equal dividend claims. For each acquisition, a daily price ratio is calculated for the 21 days in the period [ - 30, - 10] and [ + 10, + 30] relative to the announcement date. Mean values over the 21-day periods are calculated for each acquisition, and the mean and median values across acquisitions are reported in Table 3. Overall, high-vote shares sell at a significant premium to the low-vote shares.' The premium is significant both before and after the announcement period, but declines from 1.075 before the announcement to 1.063 after the announcement. While the decline is consistent with hypothesis H2, the

Table 3 Control Premium Change Surrounding Acquisition Announcements

Price Ratio (PH/PL)

All (N = 37) Before Announcement [ - 3 0 , - 1 0 ] Mean Median

^stat ( H O : L N ( P H / P J = 0) z-stat (H:median(PJ^/P^.) = 1)

VC > 1.35 1.082 1.047 2.92** 2.48" 1.057 1.023 2.27" 2.00" -0.026 -2.10*' 2.2O"

VC < 1.35 1.065 1.024 2.42'* 1.76* 1.073 1.061 2.75** 2.27** 0.008 0.90

1.075 1.024 3.94** 3.27" 1.063 1.026 3.56" 3.09** -0.012 -1.33

After Announcement [ + 10,+ 30] Mean Median

^stat ( H ( , : L N ( P H / P L ) = 0) 2-stat (H^:median(P[^/P^,) = 1) Change in Price Ratio (After Before) <-stat (Hgimean = 0) e-stat (Hgiequal means)

Notes: VC, the value of control, is the insider's percentage of votes controlled divided by percentage of total shares owned. Double (single) asterisk () indicates /-test or Wilcoxon signed rank test (i-stat) is significant at the 5% (10%) level.

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difference is not statistically reliable. Of more interest, however, is the change when the sample is partitioned at the median value of control (VC) defined by equation (1). When VC is above the median (column 2) and managers value control more highly than cash flow claims, the price ratio declines significantly {t = -2.10) from 1.082 to 1.057. When VC is below the median (column 3), on the other hand, the change in indistinguishable from zero {t = 0.90). The difference in the changes between partitions is significant {t = 2.20). These results are consistent with the notion that managers who prefer control make acquisitions which lower the likelihood that their firm will become a takeover target. In addition, results are also consistent with the notion that managers are engaging in strategic behavior designed to capture the control premium from outside shareholders if a change in control does occur. Sample Partitioned by Value of Control We investigate the association between ownership structure and announcement period wealth effects by examining returns to each class of stock and total return when the sample is partitioned at the median value of control (VC = 1.35). Table 4 reports the results of this analysis. When VC is above the median (column 1), returns to high-vote shares are significantly negative (-0.0300, t 3.00), as are total returns (-0.0192, < = -2.13), while returns to lowvote shares are negative but insignificant (-0.0145, t = - 1.45). When VC lies below the median (column 2) returns are indistinguishable from zero. Most important, returns are significantly lower when VC is above the median (column 1) than when the value of control is below the median (column 2). The difference in total return between columns 1 and 2, for example, is 3.66% {t = 2.23). Similar differences occur for each class of stock. These results provide evidence consistent with the ownership structure hypothesis (H3). When the value of control is above the median, negative abnormal returns suggest that managers who prefer voting claims to cash flow claims make wealth reducing investment decisions. To the extent that some sample firms have an acquisition program, benefits accruing from the program should be capitalized at the announcement of the first acquisition. Along the lines of Schipper and Thompson (1983), we investigate abnormal returns at the first announced acquisition for each of the 31 firms. Results, not shown in the table, parallel Table 4 columns 1 and 2, but are stronger. When the value of control (VC) falls above the median (column (1) in Table 4), high-vote, low-vote, and total returns are -0.0611, -0.0417, and -0.0490, respectively. Each return is significant at the 5% level and is significantly lower than the corresponding return when VC is below the median. These results along with returns reported in Table 4 suggest that future acquisitions are partially anticipated and the wealth effects are capitalized at the initial announcement. Clearly, this evidence suggests that entrenched managers are making acquisitions that harm outside shareholders.
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Table 4 Abnormal Returns Partitioned by Value of Control (VC) and Voting Rights (VR)
VC > 1.35
(1)

VC < 1.35

VR

VR

> 0.50
(3) -0.0086 -0.0084 58.8 0.13 -0.0042 -0.0140 64.7 0.79 -0.0055 -0.0118 58.8 0.56 34

< 0.50
(4) -0.0108 -0.0140 65.7*

(2)

High-vote Share Return mean median % negative i-stat (Hgiequal means) Low-vote Share Return mean median % negative t-stat (Hgtequal means) Total Return mean median % negative <-stat (HQ:equal means)

-0.0300*' 0.0099 -0.0188*' 0.0012 76.5" 48.6 2.40" -0.0145 -0.0171 67.6* 1.99" -0.0192** 0.0174 -0.0183** 0.0132 73.5** 40.0 2.23**
34

0.0196 0.0157 45.7

0.0096 0.0030 48.6

0.0040 -0.0047 54.3 35

0.50. VC is the owned. Total test) are at the 5% ( " )

35

Noles:

Eleven day abnormal returns partitioned by median VC = 1.35 and VR = percentage of votes controlled (VR) divided by the percentage of total shares return is the value weighted average of returns to both classes of stock. Asterisks () indicate that the mean (/-test) or median (Wilcoxon signed rank different from zero or more than half the returns are negative (binomial test) or 10% () level of significance.

Sample Partitioned by Vote Ownership To reinforce the importance of management's tilt toward voting rights, and to accentuate the result in Table 4 columns 1 and 2, we examine returns after dividing the sample at managerial vote ownership equal to 50 percent (VR = 0.50). Controlling a majority of the votes (VR > 0.5), managers are protected from hostile takeovers and have wide latitude to undertake self-serving acquisitions.^ As indicated in Table 4 columns (3) and (4), returns are indistinguishable from zero and no statistically significant differences in returns are found between partitions. Thus, it is not voting control per se, but voting control without a proportionate investment in residual cash flow claims which sharpens agency problems and leads to self-serving behavior by management.
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As a final look at the association between the value of control and the wealth effect of acquisitions, we divide the sample by the relatedness ofthe acquisition. Acquisitions are considered unrelated if the dual class firm's four-digit Standard Industrial Classification (SIC) code does not match the selling firm's four-digit SIC code (results for three-digit matching are similar). Managers have an incentive to make unrelated acquisitions with no clear-cut economic benefit to diversify their employment risk (Amihud and Lev, 1981) or to exploit their comparative advantage (Shleifer and Vishny, 1989). Hypothesis 4 suggests that in dual class firms unrelated acquisitions are more likely when managers tilt ownership toward shares with superior voting rights. Table 5 shows the results of this analysis. After dividing the sample at the median value of control (VC = 1.35), as in Table 4, we examine the relatedness ofthe acquisitions. We report returns to each class of stock and total returns.

Table 5 Value of Control and Returns to Related and Unrelated Acquisitions

VC > 1.35 N = 20 Unrelated N ^ 15 (1) High-vote Share Return mean median % negative <-stat (Hpxqual m e Low-vote Share Return mean median % negative <-stat (HQ: equal means) Total Return mean median % negative <-stat (Hgiequal means)
Notes:

VC < 1.35 N = 25 Unrelated N = 11 (3) -0.0036 0.0056 45.5 ' 0 U 1 -0.0045 0.0151 45.5 1^08 Related N = 14 W 0.0033 -0.0167 64.3 9 0.0304 -0.0082 57.1

Related N =5 (2) 0.0195 0.0378 20.0 4 5 * -0.0058 -0.0046 60.0

-0.0413" -0.0203"* 93.3*" a n s ) 2 -0.0280 -0.0200" 73.3* 0^0 -0.0339* -0.0330'* 80.0** 1.33

0.0015 -0.0011 60.0

-0.0025 0.0126 36.4 0.71

0.0212 -0.0114 57.1

Abnormal returns partitioned by median VC = 1.53 and SIC code matching. Acquisitions are related if four-digit SIC code of acquiring firm matches the four-digit SIC code of selling firm. Total return is the vzilue weighted average of returns to both classes of stock. Asterisks (*) indicate that mean (/-test) or median (Wilcoxon signed rank test) is different from zero or that more than half of the returns are negative (binomial test) at the 1% (*'*), .)% (), or 10% () level of significance. Blackwell Publishers Lid 1996

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As indicated in columns 1 and 2, 75% (15/20) ofthe acquisitions are unrelated when VC is above the median. This frequency of unrelated acquisitions is much higher than the 57% for all dual class firms. By comparison, the frequency is 67% for the matched control sample, while Morck et al. (1990) and Sicherman and Pettway (1987) report 72 percent and 67 percent unrelated acquisitions in their samples of takeovers and divestitures. Furthermore, as indicated in columns 3 and 4, only 44% (11/25) ofthe acquisitions are unrelated when VC falls below the median. The difference in proportions is statistically significant (/ = 2.15). When managers favor control over cash flow claims, despite high levels of stock ownership, managers engage in an unusually large proportion of diversifying acquisitions. Returns to each class of stock along with total returns presented in Table 5 reveal that only for unrelated acquisitions when the value of control (VC) is above the median (column 1) are returns significantly different from zero. The total return is -0.0339 {t 2.00) and 80% ofthe returns are negative. High-vote shares suffer the most pronounced wealth effect ( 0.0413, t = 2.58), with 93.3% ofthe returns being negative. Low-vote shares also suffer losses, although only nonparametric tests show significance. Negative returns are consistent with Shleifer and Vishny (1989) who argue that managers will overpay for diversifying investments that increase job security. The difference in returns between the 19 related (1.60%) and 26 unrelated (-2.06%) acquisitions is only marginally significant {p = 0.11). Morck et al. (1990) and Sicherman and Pettway (1987) also report slightly lower returns to unrelated acquisitions. Although not shown in the table, managers own relatively few cash flow claims (CR = 25.4%) when the value of control (VC) falls above the median. Managers own nearly half the outstanding shares (CR = 48.5%) when VC is below the median. By comparison, in the control sample, managers own 9.0% ofthe stock when acquisitions are unrelated and own a significantly higher {t = 2.30) 16.7% when acquisitions are related. The higher frequency of unrelated (variance reducing) investments when managerial ownership of cash flow claims is relatively low follows arguments made by Agrawal and Mandelker (1987) who find that low managerial ownership is associated with variance decreasing (unrelated) investments. Moreoever, if we divide the sample by the median value of CR, instead of VC, there is no significant difference in the proportion of unrelated acquisitions by each group. Thus, ownership of cash flow claims per se does not determine the frequency of unrelated acquisitions, but the way managers' divide ownership between cash flow claims and voting claims determines the frequency of unrelated acquisitions. In general, the evidence presented in Table 5 further supports the notion that the divergence of voting rights from cash flow claims alters the incentives associated with stock ownership. Even though managers own a lot of shares by conventional standards, when they choose to own much more ofthe shares with superior voting rights they make significantly more wealth reducing
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unrelated acquisitions. Here, although shareholders lose, managers still benefit from greater job security, from compensation related to firm size, or from diversified human capital. Comparison With Single Class Bidders To see whether dual class acquirers are different, we compare results for dual class firms with the control sample of single class bidders. First, to examine whether dual class acquisitions are worse than acquisitions by single class bidders we compare announcement period returns shown in Table 2. Abnormal returns are significantly negative for both control samples and indistinguishable from zero for the dual class sample. Matched control sample abnormal returns are -0.017 (median = -0.015) with 39.9% ofthe returns positive, while dual class returns are -0.0007 (median = -0.0096) with 43.5% ofthe returns positive. Dual class abnormal returns, however, do not differ significantly {t = 1.39) from the matched control sample abnormal returns. Although we expect that dual class acquisitions should be worse because of the agency problems associated with differential voting rights, results show that on average dual class shareholders fair no worse than shareholders of the typical acquiring firm. Significant negative returns to single class bidders are consistent with results reported by Bradley, Desai, and Kim (1988) and Jarrell, Brickley and Netter (1988).' Finally, to investigate the cross-sectional relation between returns and ownership structure we regress total returns on the value of control (VC) and stock ownership (CR). We expect a nonlinear relation and report results in Table 6 using a square root transformation of VC and CR (Qualitatively similar results obtain with a log transformation and these results are not reported). For the full control sample (N = 601), the coefficient for CR is positive but not significant {t = 1.15), while for the smaller matched control sample (N = 69) the coefficient is positive and significant at the 5.5% level (/ = 1.95). Consistent with Lewellen, Loderer, and Rosenfeld (1985), a positive coefficient suggests that higher levels of stock ownership help to align managers with shareholders. For dual class firms we estimate two regressions. Regression (1) reports the estimates with only the value of control (VC) as the independent variable. The coefficient for VC is negative and statistically significant at the 10% level (t = 1.68). Consistent with ownership structure hypothesis H3, lower returns result when managers who tilt their ownership toward high-vote shares make acquisitions. These managers are more concerned with control, and the private benefits that the acquisitions provide, than residual cash flow claims and are willing to make value reducing acquisitions. While a negative coefficient for the value of control is consistent with hypothesis H3, the regression does not control for ownership of cash flow claims. For example, consider two firms, A and B, where managers place equal
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Table 6 Dual Class and Control Sample Regressions

Dependent Variable Constant

VC

CR
0.0018 (1.15) 0.0080 (1.95)'

Adj R^ 0.001 0.040

F 1.33 3.81'

Control Sample Full Sample Return (A^ = 601) Matched Sample Return (A^ = 69) DuEil Class Sample Total Return (1) (A^ = 69) (2)
NoUs:

-0.0140 (-3.15)" -0.0395 (-2.84)" 0.0477 (1.59) 0.1043 (1.70)' -0.0389 (-1.68)* -0.0560 (-1.98)"

0.026 -0.0614 (-1.06) 0.028

2.81* 1.96

Dependent variable is the eleven-day abnormal toted returns accruing to shares of dual-class firms or control sample bidding firms. Independent variables are the square root of value of control (VC) and proportion of shares owned (CR). Double (single) asterisk (*) indicates significance at the 5% (10%) level, (-statistics are in parentheses.

value on control: VC = 2.0 for each firm. Assume managers of firm A own 20% of voting rights and 10% of cash flow claims, while firm B's managers own 60% ofthe voting rights and 30% ofthe cash flow claims. Although the same value of control would, at first, classify both management groups as equally concerned about control, only firm B's management is immune from hostile takeover and likely to pursue their own objectives. To address this concern, regression (2) reports estimates with the value of control (VC) and managerial ownership of cash flow claims (CR) as independent variables. Dual class firms' regression (2) reinforces the negative relation between returns and the value of control (VC). The coefficient of VC is significantly negative at the 5% level {t = -1.98) after controlling for share ownership (CR). The negative relation between returns and CR in regression (2) provides weak support for our notion that in dual class firms higher levels of ownership produce deeper entrenchment. The negative coefficient contrasts with control sample regression results where announcement period abnormal returns to single-class firms are directly related to stock ownership by management. Regressions for dual class firms suggest that when voting rights and cash flow claims are not proportionsJ, managerial ownership does not play a straightforward role in controlling agency conflicts. Results indicate that high levels of managerial ownership do not insure that manager and outside shareholder interests coincide. High levels of ownership combined with disparate voting rights allow managers to pursue activities which diverge from the interests
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of outside shareholders. The control sample regression results, on the other hand, suggest that substantial ownership of cash flow claims proportional to voting rights helps to control managerial incentive problems.

CONCLUSIONS

The study examines whether managers of dual class firms follow a shareholder wealth maximizing strategy when making acquisitions. Controlling nearly half of the votes on average, dual class managers are effectively shielded from the discipline of the market for corporate control and could easily follow a selfserving strategy detrimental to outside shareholders. Although, on average, dual class shareholders fair no worse than shareholders of the typical acquiring firm, owners of shares with superior voting rights suffer significant losses. When managers tilt ownership substantially toward shares with superior voting rights, the ability of managerial ownership to reduce agency conflicts breaks down and managers are likely to make value reducing acquisitions. Returns around announcements of acquisitions are significantly negative when managers prefer voting rights to residual cash flow claims. High levels of ownership are no longer sufficient to align managers' interests with the interests of outside shareholders. When managerial preference for control is strong, we find that diversifying acquisitions are more likely, and that managers seem to overpay as indicated by significantly negative returns. Overall, we interpret the evidence to indicate that managers who place a high value on control of corporate resources are willing to make acquisitions that have large private benefits, such as unrelated acquisitions designed to diversify the manager's investment in firm-specific human capital, but harm outside shareholders.

NOTES 1 Institutional details of dual class recapitalizations are described elsewhere, e.g., Seligman (1986), Gilson (1987), Fischel (1988), and Gordon (1988). The frequency of recapitalization figures are from Partch (1987) and Jarrell and Poulsen (1988). Ambiguous announcement period returns result, in part, because confounding signals accompany the recapitalization announcement. For example, announcement returns include the positive effect of higher dividends that frequently accompany the low-vote shares. Returns also include the negative impact of an upcoming equity offering, and could include the negative effect of adopting a defensive measure against hostile takeover bids. Lease, McConnell, and Mikkelson (1983 and 1984) document the control premium in US dujJ class firms, while Jog and Riding (1986) and Foerster and Porter (1993) document the premium in Canadian firms, and Megginson (1990) documents the premium in British firms. We were able to calculate the ratio ofthe target firm's equity (reported value ofthe deal for divestitures) to the acquiring firm's equity for 59 control ssunple and 42 dual class transactions. The ratio did not differ (( = 0.07) between groups, 0.55 (median = 0.23) for the control sample versus 0.56 (median = 0.23) for the dual class sample. For example, Bradley, Desai, and Kim (1988) and Lang, Stulz, and Walkling (1991) examine returns over the period from five days before the initial bid to five days after the final successful bid.

3 4

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A further breakdown of dual class returns, not reported in the tables, indicates that total returns to acquisitions classified as interfirm asset sales are positive but insignificant, while negative but insignificant returns accompany acquisitions classified as merger/tender offer. 7 Since the price ratio is not normally distributed, test statistics, as with Lease et al. (1983), test whether the mean of the natural logarithm of the price ratio is equal to zero. 8 Still, threat of litigation, influence of institutional investors, or concern about reputation could constrain managers from straying too far from the interests of outside shareholders. 9 Significant negative returns result if the control sample contains multiple-bidder takeovers, bids opposed by target firm managers, or could merely be a consequence of bidder-revelation bias (Roll, 1986; and Bhagat and Hirshleifer, 1992).

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