Workshop Series: Suman Banerjee
This paper shows that restrictions on the issuance of non-voting shares may cause managers who own equity in the firm to under-invest. When a firm issues voting shares to raise capital for new investment, there is a dilution in the manager's ownership. This increases the risk to the manager's control of the firm, decreasing his chances of obtaining the private benefits of control. The problem is most severe in firms where managers extract significant private benefits. Non-voting stock allows a firm to raise equity capital without a dilution in the manager's ownership and alleviates the under-investment problem. There are costs to the issuance of non-voting stock - managerial entrenchment, dividend dilution and firms in the control of inferior managers. The issuance of non-voting equity is optimal when the benefits, higher firm value because of higher investment outweighs the cost of managerial entrenchment and dividend dilution. We obtain conditions under which it is optimal for firms to issue non-voting stock. Our theory is consistent with the empirical findings of Faccio and Masulis (2005) who show that a fear of loss of control makes shareholders reluctant to issue voting equity to finance M&A activities. In addition, our model produces new empirical predictions regarding the relationship between the likelihood of dual-class recapitalization and incumbent management quality, management ownership and the effectiveness of other mechanisms to restrict private benefits.
Dr. Suman Banerjee is an assistant professor of finance at the Nanyang Business School in Singapore. Before joining Nanyang Business School in January 2008, Dr. Banerjee was an assistant professor of finance at the A. B. Freeman School of Business at Tulane University in New Orleans. Dr. Banerjee obtained his Ph.D. in Finance from the Henry B. Tippie School of Business, The University of Iowa in August 1999 and M.A. (Economics) from the Delhi School of Economics, India. His research interests include contracting theory with applications to areas of Corporate Finance such as corporate control, mergers and acquisitions and Energy Finance. Dr. Banerjee is the author of many academic articles in top tier finance journals like Journal of Financial Economics, Journal of Finance and Quantitative Analysis, Journal of Business and Journal of Corporate Finance. At NBS, Dr. Banerjee teaches the Financial Risk Management both at the graduate level as well as the undergraduate level. At Tulane University, he taught Derivative Securities and Corporate Risk Management at the graduate level and Fixed Income Analytics at the undergraduate level. He coordinates with Bloomberg Inc., on fixed income project valuation and design of Bloomberg Aptitude Test. He coordinates with RiskLimited Corporation, an energy consulting company, on project efforts on energy research and publications. He received the Bank Scope Best Paper Award from The Australian Banking and Finance Association meeting in 2010. He was awarded Caesarea Institute Award for the best paper in risk management from the prestigious Western Finance Association in July 2002. He was honored as a Junior Research Fellow by the Indian University Grants' Commission in 1993 and given the Honorary Fellowship by the Beta Gamma Sigma in 1999. He has obtained several other merit-based awards and competitive research grants in the course of his academic career.