Lucian Bebchuk is James Barr Ames Professor of Law, Economics and Finance, and Director of the Corporate Governance Program, at Harvard Law School. Kobi Kastiel is Research Director of the Program’s Project on Controlling Shareholders and Assistant Professor at Tel-Aviv University Faculty of Law. This post is based on their recent study, available here.
Dropbox filed IPO documents last week, and our analysis of these documents reveals considerable risk that the company’s co-founders would hold lifetime control even if they would retain only a tiny minority of the company’s equity capital. In a study that we just placed on SSRN, The Perils of Small-Minority Controllers, we seek to place 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.
We analyze 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 also identify the mechanisms that enable such controllers to retain their power despite holding a small or even a tiny minority of the company’s equity capital. Based on a hand-collected analysis of governance documents of these companies, we present novel empirical evidence on the current incidence and potential growth of small-minority and tiny-minority controllers. Among other things, we show that governance arrangements at a substantial majority of dual-class companies enable the controller to reduce his equity stake to below 10% and still retain a lock on control, and a sizable fraction of such companies enable retaining control with 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 disclosures necessary to make transparent to investors the extent to which 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 ensure that controllers maintain a minimum fraction of equity capital; to provide public investors with extra protections in the presence of small-minority controllers; or to screen midstream changes that can introduce or increase the costs of small-minority controllers.
Below we provide a more detailed account of our analysis:
