Volume 107
Issue 6
July '19

The Perils of Small-Minority Controllers

Written By: Lucian A. Bebchuk & Kobi Kastiel

Abstract

This Article contributes to the longstanding and heated debate over dual-class companies by placing a spotlight on a significant set of dual-class companies whose structures raise especially severe governance concerns: those with controllers holding a small minority of the company’s equity capital. Such small-minority controllers dominate some of the country’s largest companies, and we show that their numbers can be expected to grow.

We begin by analyzing the perils of small-minority controllers, explaining how they generate considerable governance costs and risks and showing how these costs can be expected to escalate as the controller’s stake decreases. We then identify the mechanisms that enable such controllers to retain their power despite holding a small or even tiny minority of the company’ s equity capital. Using a hand-collected dataset of the governance documents of these companies, we present novel empirical evidence of the current incidence and potential growth of small- minority and tiny-minority controllers. Among other things, we show that governance arrangements at over 80% of dual-class companies enable the controllers to reduce their equity stake to below 10% and still retain a lock on control, and that a sizable fraction of such companies enable retaining control with even less than a 5% stake.

Finally, we examine the considerable policy implications that arise from recognizing the perils of small-minority controllers. We first discuss the disclosures necessary to make transparent to investors the extent to which governance arrangements enable controllers to reduce their stake without forgoing control. We then identify and examine measures that public officials or institutional investors could take to (i) ensure that con- trollers maintain a minimum fraction of equity capital, (ii) provide public investors with extra protections in the presence of small-minority con- trollers, or (iii) screen midstream changes that can introduce or increase the costs of small-minority controllers.

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