Control Rights, Economic

Rights and Incentives

Shiheng Wang
ACCT5320– Spring 2023

Week 1
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 Learning Objectives
• Distinguish between control rights and economic rights

• Why is control valuable?

(1) Private benefits of control
— example mechanism: corporate pyramids

(2) Strategic benefits of control

— example mechanism: dual class shares

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 Economic Rights and Control Rights
Share of
Voting Stock

Cash Flow Rights Voting Rights

Right to dividends and capital gains Right to influence & perhaps control
•choose board members
•hire, fire and set compensation of CEO
•strategic decisions (e.g., acquisitions)

Properly combining the two aspects

provides strong incentives for the owner
to maintain or increase asset value.
Skin in the game!

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 Economic Rights and Control Rights
Share of
Voting Stock

Cash Flow Rights Voting Rights

Right to dividends and capital gains Right to influence & perhaps control
•choose board members
•hire, fire and set compensation of CEO
•strategic decisions (e.g., acquisitions)

May lead to diverging incentives

between controlling and non-
controlling shareholders.

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 Example of Control Wedge-Pyramid

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 Example of Control Wedge-Dual Class
• Google has a “Dual Class” share structure. Each share has the same cash flow
rights, but Class B shares each have 10 votes to 1 vote for a Class A share.

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 Example of Control Wedge-Dual Class
• Applicable percentage ownership is based on 300.05M shares of Class A
common stock and 46.41M shares of Class B common stock outstanding at April
7, 2020

Economic Rights= 19.95M+19.19M+3.94M+0.11M =12.5%

46.41M+300.05M

10*(19.95M+19.19M+3.94M)+0.11M
Voting Rights= =56.4%
10*46.41M+300.05M

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 Why is Control Valuable
1) Private Benefits of Control
– Value of control derives from the option to “steal”.
– Opportunity for the majority to expropriate wealth of the minority.
– Benefits not shared by all shareholders.
Total Wealth Total Wealth
without Private Benefits with Private Benefits Outer ring stolen
by controlling
shareholder

Private Benefits
of Control Inner circle split
b/w controlling and
non-controlling
shareholders
Non-controlling shareholders’ wealth from economic claim on the firm
Controlling shareholder wealth from economic claim on the firm
Controlling shareholder wealth from expropriation of firm wealth

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 Control Rights ≠ Economic Rights:
Using Pyramids To Extract Private Benefits
$9
PARENT
Shareholders
100% PARENT

30% $9

$21
Other
Shareholders 70%
Subsidiary
of B B Assuming:
Good Governance

30% $30

$70 Unaffiliated party does

Other
Shareholders 70%
Subsidiary an arms-length deal
C $100 Profit with C, generating $100
of C
in profits for C

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 Asymmetric Control and Economic Rights:
Corporate Pyramids
$0
$9

PARENT
Shareholders
100% PARENT

Nets $91 $0
$100 by stealing! 30%
$9
$0
$21
Other
Shareholders 70%
Subsidiary
of B B Assuming:
Poor Governance
$0
30%
$30
$0
$70
Other Party affiliated with
Shareholders 70%
Subsidiary Parent shareholders
C $0 Profit
of C low-balls deal with C
→ $0 profits to C

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 Asymmetric Control and Economic Rights

• U.S. example

Perry Corp.
7M Shares
(Hedge Fund)

July 2004
Mylan announces
plans to acquire King
To help Mylan receive
shareholder approval
for the merger and
increase the offer price.

9.9% Ownership

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 Asymmetric Control and Economic Rights

• Perry Corp. owns a 9.9% voting and economic interest in Mylan.

– By influencing Mylan to pay a higher purchase price for King, isn’t Perry Corp.
simply stealing money from themselves?

• Who is on the losing end of this strategy?

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 Estimating the Private Benefits of Control
• Intrinsically difficult to measure
– Controlling parties are more likely to appropriate value for themselves when
this value is not verifiable (e.g., provable in court).

• Use transfers of controlling blocks in publicly traded companies

– Compare the price per share paid for the control block (P control) and the
price at which shares are trading on the exchange two days after the
announcement (P exch) .
– Estimating the control premium as a percentage of equity:

Control Premium P  P exch  Shares Acquirer

control
= exch
× × 100%
Equity P SharesTotal

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 Estimating the Private Benefits of Control
Example (Dyck and Zingales, 2004)
In January 1999, Ofer Brothers Investment Limited bought
53% of the shares and control of Israel Corporation
Limited. The price per share for the control block was
reported to be 508 ₪ /shr while the exchange price after
announcement of the transfer was 363₪ /shr.

Control Premium  508  363 

= × 0.53 ×100%  21%
Equity 363

Private Benefits of Control is decreasing in:

 Rights to sue management
 Product market competition
 Labor pressures
 Diffusion of the press (reputation effects)
 Rate of tax compliance (restrict certain transactions)

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 Implications for M&A
• Companies that require more capital are typically located at the bottom
of a pyramidal group so that the ultimate controlling shareholder can
participate in their equity financing by paying only a modest fraction.
• The ultimate controlling shareholder is incentivated to acquire another
company for more than its value as he would bear only a minor fraction
of the wealth loss, once the loss could be more than offset by the private
benefits the controlling shareholder can exploit from the new controlled
firm.
• Tunneling could a major motivation for acquisitions within a business
group, such as chaebol, if acquiring bad target group members maximizes
the aggregate value of the business group or the welfare of controlling
owners.
• Payment for target = V(Stand-alone value)+V(synergy)+V(control
premium)
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 Why is Control Valuable
2) Strategic Benefits of Control
– Value of control derives from the option to direct the strategy of the firm in
ways that always maximize value for shareholders.

• Outer ring represents

increase in firm value
via good decisions of
controlling shareholder
• Increase split between
controlling and non-
Strategic Benefits controlling shareholders

of Control

Total Wealth
without Strategic Benefits Total Wealth
with Strategic Benefits
Non-controlling shareholders’ wealth from economic claim on the firm
Controlling shareholder wealth from economic claim on the firm

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 Excerpts from Proxy Statement

Their message:
With us in control,
Strategic Flexibility we will create
of Control outer ring value
Size of pie without us in control Economic and you will share
Rights in it

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 Tisch Family Ownership and Control in CBS
CBS was controlled by the Tisch brothers, Laurence
and Preston Robert, through their 32% ownership
stake in Loews Corp. Loews owned 100% in LT
Holding, which in turn owned 17.63% of all shares
and votes in CBS.

O (shares owned) = 32% × 17.63% + 0.32% = 5.96%

V (votes owned ) = 32% × 17.63% + 0.32% = 5.96%

C (votes controlled) = 17.63% + 0.32% = 17.95%

Wedge = 17.95% ‒ 5.96% = 11.99%

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 Cox Family Ownership & Control in Cox Communications
This structure contains elements of both
pyramids and dual class shares. Anne Cox
Chambers and Barbara Cox Anthony are
daughters of founder James Middleton Cox.
James Cox Kennedy is son of Barbara Cox
Anthony. Garner Anthony is husband of
Barbara Cox Anthony, and James Cox
Kennedy’s stepfather. Sarah Kennedy is
James Cox Kennedy’s wife.

Family owns 98.51% of Cox Enterprises

O (shares owned) = 98.51% × (62.3% + 4.4%) + 0.01% =

63.71%

V (votes owned ) = 98.51% × (71.2% + 5.1%) + 0.01% =

75.16%

C (votes controlled) = 71.2% + 5.1% + 0.01% = 76.31%

Wedge = 76.31% ‒ 63.71% = 12.6%

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 Voting Right vs. Control Right
Controlling right means ownership has to pass certain threshold

5% 80%
(1) A B C A does not control C, B controls C

40% 30%
(2) A B C A in C: voting right 12%, control right 30%

50% 20%
(3) A B C A in C: voting right 10%, control right 20%

Control right is the weakest link in the “control chain”

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 Exercise
• Assume each share of equity conveys equal voting and cash flow
rights.
• Control over more than 50% of the votes is necessary to control an
investee.
• The direction of the arrow indicates the direction of the ownership
interest. The number inside the oval represents the fraction of
shares owned by the investee. For example, in the diagram below,
A owns 10% of B.

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 Exercise

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 Exercise

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 Exercise

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 Cash Flow Rights, Control Rights & Large Shareholders
• Many firms around the world are controlled by a large shareholder,
typically founders or their families.

• Even in the U.S., where ownership dispersion is at its highest,

founding families exercise a significant degree of control over one
third of the 500 largest corporations.

• Founding families are often able to leverage their control over and
above their sheer equity stake through mechanisms such as dual-
class stock, pyramid ownership, and cross-holdings.

• Research convincingly documents that firm value is reduced when

founders or their families use control-enhancing mechanisms to
create a wedge between their cash-flow and control rights!

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