New research finds that tightly controlled companies tend to underperform more widely held firms in a number of ways.
A study commissioned by the New York City-based Investor Responsibility Research Center Institute (IRRC Institue) and conducted by Institutional Shareholder Services Inc. (ISS) finds that closely controlled companies (defined as any person or group owning 30% or more of a company’s voting power), particularly those with multiple classes of shares, experience more stock price volatility, have more material weaknesses in accounting controls, engage in more related party transactions, and offer fewer rights to unaffiliated shareholders.
In particular, the study found that non-controlled firms outperformed controlled firms over the three-, five-, and 10-year periods ended August 31. Controlled companies featuring multi-share classes only outperformed over the shortest time period measured, one year, and materially underperformed over longer periods of time, it found.
“The results challenge the notion that multi-class voting structures benefit a company and its shareowners over the long term,” the IRRC Institute says. Nevertheless, the study found that the number of controlled companies has increased over the last decade.
The study also observed that, while institutional investors have concerns with investing in controlled companies, they generally do not have formal policies concerning such firms. Most investors report that controlled firms are less responsive to their inquiries and engage in less outreach than non-controlled firms, it says.
“Investors have long taken a limited view toward controlled firms with multi-class capital structures because of such structures’ inherent negative impact on the rights of unaffiliated shareholders,” said Sean Quinn, report author and vice president with ISS. “This study finds that in addition to offering unaffiliated shareholders comparatively fewer rights, these firms underperform and show higher levels of risk than their single-class peers,” he said.
“Supporters of these structures claim that control of a company’s voting power enables management to govern with minimal outside interference and focus on long-term business growth, and ultimately deliver higher returns to shareholders in exchange for control rights. However, the study finds the opposite to be true,” said Jon Lukomnik, IRRC Institute executive director.
“When control is exercised through multiclass structures, those companies perform worse and are more risky. In contrast, when company control is aligned with unaffiliated investors in a single class of stock, the result is companies perform better over the long haul and are less risky. Alignment matters. The method of control matters,” he added.