Holders of large blocks of a company’s shares are pervasive in developed economies. La Porta et al. (1999) find that only 17 percent of large firms in countries with strong shareholder protection qualify as widely-held, and Holderness (2009) shows that 96 percent of large U.S. firms have blockholders who own at least 5 percent of a company’s stock. Blockholders influence corporate policies in many ways, with voting being arguably the most important, as it empowers shareholders to elect directors, approve major corporate transactions, and decide on governance issues. Since voting rights and dividend rights are bundled together in shares, blockholders’ desire to accumulate voting power and determine voting results may give rise to a voting premium on the price of a firm’s shares.
In a new paper, The Voting Premium, we develop a theory of blockholder governance and study company ownership structure in a context in which blockholders exercise control through voting. Our key focus is on the conditions under which blockholders are willing to pay higher prices for a firm’s shares to exercise more voting control, when their trades give rise to a voting premium, and how empirical estimates of the voting premium should be interpreted.
We analyze a model with many dispersed shareholders and a blockholder. All shareholders first trade with each other in a competitive stock market, and shareholders who own the firm after trading then vote on a proposal at a shareholder meeting. Shareholders differ in their attitudes to the proposal: Some are biased in favor of the proposal and others against it. For example, investors differ in their time horizons, risk aversion, ownership of other firms, and attitudes to social and political issues.
In this setting, the blockholder trades not only because he believes the firm to be overvalued or undervalued, but also to accumulate voting rights, and we show how this voting motive translates into a voting premium on the firm’s shares. For example, if a firm has a dual-class share structure, this voting motive leads to a price difference between voting and non-voting shares.
We highlight that the key factor that determines the voting premium is the identity of the median voter, whose preferences put him in the middle between those who are biased in favor of a proposal and those who are biased against it. Therefore, the median voter is the shareholder whose vote coincides with the final decision on the proposal. Trading by the blockholder affects the location of the median voter and moves him, and thereby the voting outcome, in the direction preferred by the blockholder. This leads to the following implications about the determinants and properties of the voting premium.
The voting premium does not measure the value of voting power. The voting premium is zero if the blockholder is the median voter, since then the purchase of an additional share by the blockholder does not affect the voting outcome. Hence, the voting premium does not emerge from the blockholder exercising control, but from him influencing who among the other shareholders exercises control. However, a zero voting premium does not imply that the value of votes to the blockholder is zero. For example, when the blockholder has a large stake and therefore a good chance of influencing the outcome, then his voting power is large and his valuation of the votes tends to be large, even though the voting premium is often zero. The reason is that the voting premium depends only on how much the blockholder would be willing to pay for one additional share, which is very different from the value of an entire block of shares. Hence, our results emphasize that common empirical measures of the voting premium may not provide correct estimates of the actual value of voting rights to their owners.
The voting premium can be negative. In some cases, buying shares and accumulating voting control benefit the average dispersed shareholder more than the blockholder himself. Then the blockholder’s purchases put an upward pressure on the stock price and increase the price he pays by more than his own valuation. In this case, the blockholder buys fewer shares to prevent such free-riding of dispersed shareholders, which gives rise to a negative voting premium. Consistent with this prediction, several empirical studies report negative voting premiums for some companies (e.g., Rydqvist (1996); Nenova (2003); and Albuquerque and Schroth (2010)).
The voting premium may be positive even if blockholders exit. The blockholder may choose to exit and sell shares to dispersed shareholders and thereby give up his influence on voting results. However, then the blockholder demands a premium from the dispersed shareholders for giving up control. Hence, a positive voting premium does not necessarily indicate a more concentrated ownership structure.
The voting premium increases if blockholders compete for influence. Empirical studies of the voting premium show that the relationship between it and ownership concentration can be positive or negative: The value of voting rights is small if ownership is either very dispersed or very concentrated with one blockholder having majority control, but that value is higher for intermediate levels of ownership concentration. Our analysis emphasizes that, with multiple blockholders, it is not only the concentration of ownership that matters but also their preferences. If blockholders have similar preferences, then ownership concentration is positively correlated with the voting premium. Interestingly, if blockholders disagree with each other, the voting premium increases the more they disagree, as they try to accumulate voting power to counteract the power of other blockholders.
Markets for votes may not be sufficient for blockholders to achieve their desired voting outcomes. Voting rights and dividend rights are bundled together in shares of common stock. However, voting rights can be separated from dividend rights, e.g., through dual-class shares, the ability to trade synthetic shares in derivative markets, or share lending. Such a separation effectively creates a separate market for voting rights. We ask whether the existence of such a market can help the blockholder achieve his objectives. We show that only blockholders with moderate preferences can use the market for votes to successfully pursue their agendas, whereas blockholders with strong views cannot. Thus, blockholders with strong views may resort to other channels of corporate influence, such as engaging with management behind the scenes, lobbying other shareholders and proxy advisers, or running media campaigns. This result is consistent with the evidence in McCahery, Sautner and Starks (2016) that institutional investors use a broad range of governance mechanisms to influence their portfolio companies.
Overall, our paper contributes to the literature by analyzing how and when a voting premium emerges when blockholders can acquire voting control through trading in the equity market. We show that the voting premium emerges from blockholders influencing who exercises control and not from blockholders exercising control directly. Moreover, blockholders with strong views may resort to strategies other than voting to influence firms’ policies. We also show that the dual-class share premium and other empirical measures of the voting premium do not reflect the economic value of voting rights to the blockholder. In particular, the voting premium is unrelated to measures of voting power, and even a negative voting premium can emerge.
Albuquerque, Rui A., and Enrique Schroth, 2010, Quantifying Private Benefits of Control from a Structural Model of Block Trades, Journal of Financial Economics 96:1, pp. 33-55.
Holderness, Clifford G., 2009, The Myth of Diffuse Ownership in the United States, Review of Financial Studies 22:4, pp. 1377-1408.
La Porta, Rafael, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert Vishny, 1999, Corporate Ownership around the World, Journal of Finance 54:2, pp. 471-517.
McCahery, Joseph A, Zacharias Sautner, and Laura T Starks, 2016, Behind the Scenes: The Corporate Governance Preferences of Institutional Investors, Journal of Finance 71:6, pp. 2905–2932.
Nenova, Tatiana, 2003, The Value of Corporate Votes and Control Benefits: A Cross-Country Analysis, Journal of Financial Economics 68:3, pp. 325-351.
Rydqvist, Kristian, 1996, Takeover Bids and the Relative Prices of Shares That Differ in Their Voting Rights, Journal of Banking and Finance 20:8, pp. 1407-25.
This post comes to us from professors Doron Levit at the University of Washington’s Foster School of Business and the European Corporate Governance Institute (ECGI), Nadya Malenko at the University of Michigan’s Stephen M. Ross School of Business and ECGI and the Centre for Economic Policy Research, and Ernst G. Maug at the University of Mannheim Business School and ECGI. It is based on their recent article, “The Voting Premium,” available here.