Earnings and the Value of Voting Rights

Umit Gurun is Professor of Accounting and Finance at the University of Texas at Dallas Naveen Jindal School of Management, and Oğuzhan Karakaş is Assistant Professor of Finance at Boston College Carroll School of Management. This post is based on their recent paper.

In our recent paper, Earnings and the Value of Voting Rights, we examine the impact of earnings announcements on the value of shareholder voting rights (i.e., voting premium). Earnings are associated with and indicative of the efficiency in the management of the company. We contend that earnings not only inform investors regarding the risky stream of cash flows (ownership role), but also influence the control rights by providing a benchmark for shareholders to express their concerns with corporate performance and to pressure management for corporate reform (control role). This dual role of earnings naturally maps into the separation of ownership and control functions in modern corporations.

It is difficult to discern the control role of earnings simply because voting rights are hard to isolate from cash flows. We overcome this problem by utilizing a new, market-based, and daily measure of the value of shareholder voting rights introduced in Kalay, Karakaş, and Pant (2014). Specifically, we define voting premiumas the price difference between the stock and the non-voting share that is synthesized using the put-call parity relation, expressed as a percentage of the stock price. The key insight of this method is that option prices reflect the cash flows of the underlying stocks, but not the control rights. Unlike previously proposed methods of estimating control value such as using trades of block shareholders or dual-class stocks, our method enables us to estimate the voting premium for a large sample of widely held firms and hence is less subject to concerns of selection biases.

Analyzing 4,481 US public firms over the period 1996 to 2013, and earnings surprises based on seasonal random walk expected earnings, we show that the value of voting rights is negatively related to earnings surprises, i.e., a firm’s voting premium increases with the unfavorable earnings surprises. This baseline result of negative relation between voting premium and earnings surprises is robust to controlling for firm size, book-to-market, absolute abnormal returns around the earnings announcements, firm and year fixed effects. The result is primarily driven by negative earnings surprises, rather than positive earnings surprises. Our findings suggest that unfavorable earnings reflect, and possibly trigger, the potential disagreements among investors regarding the management of the firms’ assets and increase the chances of a control contest, which in turn increases thevoting premium.

Our results are not driven by other related factors that may cause biases in our estimates, such as potential litigation expectations and dividend changes following earnings announcements or voluntary disclosures prior to earnings announcements. We find that the negative relation between voting premium and earnings surprises is strengthened in the presence of impending shareholder meetings, and attenuated when managerial incentives are aligned with shareholders. Our results also hold we when use analyst consensus expected earnings in the calculation of earnings surprises, instead of using seasonal random walk earnings. Finally, and importantly, we find that variation in the value of voting rights attributed to earnings surprises predicts future exercises of control, such as CEO turnovers, acquisition offers, and corporate restructurings.

Our paper contributes to the literature on corporate governance/control and accounting by highlighting the control role of the information released in the earnings announcements. Although we focus on the earnings announcements in this study, we believe our insight and technique of separating the cash flow and voting components of the stock can be applied to other important corporate governance/control and accounting disclosure issues.

The full paper is available for download here.

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