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In many markets, it is common for the voting rights to vary across different classes of shares. The shares that carry no or fewer voting rights should be worth less than shares that carry more voting power and the difference in price should be a function of the expected value of control.
The Premium for Voting Shares
To link the premium on voting shares to the expected value of control, let us begin with an extreme and very simplistic example. Assume that you have a company with nv voting and nnv non-voting shares and that the voting shareholders have complete and total control of the business. Thus they are free to ignore the views of non-voting shares in the event of a hostile takeover and negotiate the best deal that they can for themselves with the acquirer. Assume further that this firm has a status quo value of Vb and an optimal value of Va and that the likelihood of management changing in this firm is π. Since the non-voting shares have absolutely no say in whether the management can be changed, the value per non-voting share will be based purely upon the status quo value: Value per non-voting share = Vb/ (nv + nnv)
The voting shares will trade at a premium that reflects the expected value of control:
Value per voting share = Vb/ (nv + nnv) + (Va - Vb) π/ nv
The premium on voting shares should therefore be a function of the probability that there will be a change in management at that firm (π) and the value of changing management (Va - Vb).
To the extent that non-voting shareholders are protected or can extract come of the expected value of control, the difference between voting and non-voting shares will be lower. It is possible, for instance, for non-voting shares to gain some of the value of control if it is accomplished by changing managers, rather than by a hostile takeover. In that case, the value of the firm will increase and all shareholders will benefit.
Implications
If the primary reason for the voting share premium is the value of control, there are several conclusions that follow:
a. The difference between voting and non-voting shares should go to zero if there is no chance of changing management/control. This will clearly be a function of the concentration of ownership of the voting shares. If there are relatively few voting shares,held entirely by insiders, the probability of management change may very well be close to zero and voting shares should trade at the same price as non-voting shares. If, on the other hand, a significant percentage of voting shares is held by the public, the probability of management change should be higher and the voting shares should reflect this premium.
b. Other things remaining equal, voting shares should trade at a larger premium on nonvoting shares at badly managed firms than well-managed firms. Since the expected value of control is close to zero in well-managed firms, voting shares and non-voting shares should trade at roughly the same price in these firms. In a badly managed firm, the expected value of control is likely to be higher, as should the voting share premium.
c. Other things remaining equal, the smaller the number of voting shares relative to nonvoting shares, the higher the premium on voting shares should be. Since the expected value of control is divided by the number of voting shares to get the premium, the smaller that number, the greater the value attached to each share. This has to be weighed off against the reality that when the number of voting shares is small, it is more likely to be held entirely by incumbent managers and insiders, thus reducing the likelihood of
management change.
d. Other things remaining equal, the greater the percentage of voting shares that are available for trading by the general public (float), the higher the premium on voting shares should be. When voting shares are entirely or predominantly held by managers and insiders, the probability of control changing is small and so is the expected value of control.
e. Any event that illustrates the power of voting shares relative to non-voting shares is likely to affect the premium at which all voting shares trade. The expected value of control is a function of perceptions that management at these firms can be changed. In a market where incumbent managers are entrenched, voting shares may not trade at a premium because investors assess no value to control. A hostile acquisition in this market or a regulatory change providing protection to non-voting shareholders can increase the expected value of control for all companies and, with it, the voting share premium.
In summary, then, we would expect the voting share premium to be highest in badly managed firms where voting shares are dispersed among the public. We would expect it to be smallest in well managed firms and in firms where the voting shares are concentrated in the hands of insiders and management.
Empirical Evidence
Shares with different voting rights are unusual in the United States, especially among larger market capitalization companies. Notwithstanding this fact, the earliest studies of voting share premiums were done with companies with different voting share classes in the United States. Lease, McConnell and Mikkelson (1983) found that voting shares in that market trade, on average, at a relatively small premium of 5-10% over nonvoting shares.They also found extended periods where the voting share premium disappeared or voting shares traded at a discount to non-voting shares, a surprising finding that can be explained partially by the relative illiquidity of voting shares (since only a small percentage is available for public trading). The small premium commanded by voting shares was confirmed by Zingales in a study in 1995.55 Studies in recent years have expanded the analysis of voting share premiums to other markets, where differential voting rights are more common. Premiums of a magnitude similar to those found in the United States (5-10%) were found in the United Kingdom and Canada. Much larger premiums are reported in Latin America (50-100%), Israel (75%) and Italy (80%). In a comparative study of voting premiums across 661 companies in 18 countries, Nenova (2000) concludes that the legal environment was the key factor in explaining differences across countries and that the voting premium is smaller in countries with better legal protection for minority and non-voting stockholders and larger for countries without such protection.
The Premium for Voting Shares
To link the premium on voting shares to the expected value of control, let us begin with an extreme and very simplistic example. Assume that you have a company with nv voting and nnv non-voting shares and that the voting shareholders have complete and total control of the business. Thus they are free to ignore the views of non-voting shares in the event of a hostile takeover and negotiate the best deal that they can for themselves with the acquirer. Assume further that this firm has a status quo value of Vb and an optimal value of Va and that the likelihood of management changing in this firm is π. Since the non-voting shares have absolutely no say in whether the management can be changed, the value per non-voting share will be based purely upon the status quo value: Value per non-voting share = Vb/ (nv + nnv)
The voting shares will trade at a premium that reflects the expected value of control:
Value per voting share = Vb/ (nv + nnv) + (Va - Vb) π/ nv
The premium on voting shares should therefore be a function of the probability that there will be a change in management at that firm (π) and the value of changing management (Va - Vb).
To the extent that non-voting shareholders are protected or can extract come of the expected value of control, the difference between voting and non-voting shares will be lower. It is possible, for instance, for non-voting shares to gain some of the value of control if it is accomplished by changing managers, rather than by a hostile takeover. In that case, the value of the firm will increase and all shareholders will benefit.
Implications
If the primary reason for the voting share premium is the value of control, there are several conclusions that follow:
a. The difference between voting and non-voting shares should go to zero if there is no chance of changing management/control. This will clearly be a function of the concentration of ownership of the voting shares. If there are relatively few voting shares,held entirely by insiders, the probability of management change may very well be close to zero and voting shares should trade at the same price as non-voting shares. If, on the other hand, a significant percentage of voting shares is held by the public, the probability of management change should be higher and the voting shares should reflect this premium.
b. Other things remaining equal, voting shares should trade at a larger premium on nonvoting shares at badly managed firms than well-managed firms. Since the expected value of control is close to zero in well-managed firms, voting shares and non-voting shares should trade at roughly the same price in these firms. In a badly managed firm, the expected value of control is likely to be higher, as should the voting share premium.
c. Other things remaining equal, the smaller the number of voting shares relative to nonvoting shares, the higher the premium on voting shares should be. Since the expected value of control is divided by the number of voting shares to get the premium, the smaller that number, the greater the value attached to each share. This has to be weighed off against the reality that when the number of voting shares is small, it is more likely to be held entirely by incumbent managers and insiders, thus reducing the likelihood of
management change.
d. Other things remaining equal, the greater the percentage of voting shares that are available for trading by the general public (float), the higher the premium on voting shares should be. When voting shares are entirely or predominantly held by managers and insiders, the probability of control changing is small and so is the expected value of control.
e. Any event that illustrates the power of voting shares relative to non-voting shares is likely to affect the premium at which all voting shares trade. The expected value of control is a function of perceptions that management at these firms can be changed. In a market where incumbent managers are entrenched, voting shares may not trade at a premium because investors assess no value to control. A hostile acquisition in this market or a regulatory change providing protection to non-voting shareholders can increase the expected value of control for all companies and, with it, the voting share premium.
In summary, then, we would expect the voting share premium to be highest in badly managed firms where voting shares are dispersed among the public. We would expect it to be smallest in well managed firms and in firms where the voting shares are concentrated in the hands of insiders and management.
Empirical Evidence
Shares with different voting rights are unusual in the United States, especially among larger market capitalization companies. Notwithstanding this fact, the earliest studies of voting share premiums were done with companies with different voting share classes in the United States. Lease, McConnell and Mikkelson (1983) found that voting shares in that market trade, on average, at a relatively small premium of 5-10% over nonvoting shares.They also found extended periods where the voting share premium disappeared or voting shares traded at a discount to non-voting shares, a surprising finding that can be explained partially by the relative illiquidity of voting shares (since only a small percentage is available for public trading). The small premium commanded by voting shares was confirmed by Zingales in a study in 1995.55 Studies in recent years have expanded the analysis of voting share premiums to other markets, where differential voting rights are more common. Premiums of a magnitude similar to those found in the United States (5-10%) were found in the United Kingdom and Canada. Much larger premiums are reported in Latin America (50-100%), Israel (75%) and Italy (80%). In a comparative study of voting premiums across 661 companies in 18 countries, Nenova (2000) concludes that the legal environment was the key factor in explaining differences across countries and that the voting premium is smaller in countries with better legal protection for minority and non-voting stockholders and larger for countries without such protection.
