Knowledge that Transforms

In this paper, we derive conditions under which the simple majority voting rule for electing controlling management and one share-one vote constitute a socially optimal corporate governance rule. We also show that other majority rules and/or multiple classes of shares are not socially optimal. Finally we show that an entrepreneur would choose to issue two securities, one with only cash flow claims and no votes and one with only votes and no cash flow claims, if this were allowed. This scheme, regardless of the majority rule adopted, is not socially optimal.

We analyze 114 NYSE- or AMEX-listed corporations with majority shareholders. Majority shareholders are approximately equally divided between corporations and individuals and are typically both directors and officers. When majority blocks trade, stock prices increase and there is substantial management turnover. Although majority shareholders are typically paid larger salaries than officers in diffusely held firms, the difference is small and of marginal significance. Investment policies, the frequency of corporate-control transactions, accounting return, and Tobin's Q are similar for majority-owned and diffusely held firms. Differences in these dimensions do emerge, however, between firms with corporate and individual majority shareholders.

This paper analyzes how managerial control of voting rights affects firm value and financing policies. It shows that an increase in the fraction of voting rights controlled by management decreases the probability of a successful tender offer and increases the premium offered if a tender offer is made. Depending on whether managerial control of voting rights is small or large, shareholders' wealth increases or falls when management strengthens its control of voting rights. Management can change the fraction of the votes it controls through capital structure changes, corporate charter amendments, and the acquisition of shareholder clienteles.

This paper uses maximum-likelihood factor analysis of large cross-sections to examine the validity of the arbitrage pricing theory (APT). We are unable to explain the expected returns on firm size portfolios, although we do explain the expected returns on portfolios formed on the basis of dividend yield and own variance, where risk adjustment using the usual CAPM market proxies fails. We also compare alternate versions of the APT and sharply reject the hypothesis that basis portfolios formed to mimic the factors span the mean-variance frontier of the individual assets.

Firms paying greenmail, i.e., repurchasing a block of stock on favorable terms from a particular shareholder or shareholders, experience above-average management turnover within one year of the payment. This high turnover is not necessarily connected only with the greenmail payment, since it follows other evidence of conflict between the target company and its shareholders. Since companies paying greenmail experience positive stock returns before the management change, the high management turnover is not related to poor share-price performance. Given that greenmail harms shareholders, our findings support the view that internal mechanisms monitor top management activity.

We analyze the effect of parameter uncertainty on equilibrium asset prices. For the symmetric case, when the amount of estimation risk is the same for all securities, the existing literature argues that parameter uncertainty is largely irrelevant for equilibrium. Our results differ. We find that symmetric estimation risk affects equilibrium values of relative asset prices, expected returns, market weights, and betas.