empirical evidence on the relative valuation of voting and restricted voting shares

EMPIRICAL EVIDENCE ON THE RELATIVE VALUATION ... ROBINSON & WHITE

Empirical Evidence on the Relative Valuation of Voting and Restricted Voting Shares

Chris Robinson York University

Alan White University of Toronto

Abstract The existence in Canada of pairs of listed voting and

restricted or non-voting common shares issued by the same company provides a unique opportunity for research on the relationship of share valuation to ownership structure, takeovers and conversion options. The evidence shows that the relative valuation is most often affected by whether or not the biggest shareholder has majority voting control. Some restricted voting shares have the explicit right to participate in takeover premia, while other restricted voting shares lack this right. This takeover participation right appears to affect the relative valuation only after a major court decision confirmed its enforceability. Another differential feature is the extension of a conversion option to some voting shares. This option does not appear to have a signifcant effect on the relative valuation of the shares.

Rhumb AM Canada, l'existence couple'e d'actions ordinaires

enregistrhes avec droit de vote et d'actions ordinaires enregistre'es avec droit de vote restreint OM sans droit de vote - e'mises par la m2me compagnie - ouvre un champ unique de recherche sur la relation entre la valeur estime'e des actions et la structure de I'actionnariat, les acquisitions et les options de conversion. La demonstration montre que la valeur estime'e relative est le plus souvent affecte'e par le fait que, oui OM non, le principal actionnaire possPde le control de la majorite' des votes. Certaines actions a droit de vote restreint ont le droit explicite de participation aux primes d'acquisitions, alors que d'autres actions a droit de restreint n'ont pas ce droit. Le droit de participation aux acquisitions ne semble affecter la valeur relative que lorsqu'une decision de justice de majeur importance a confirme' son caractPre executoire. Une autre caracteristique est l'attrihution d' une option de conversion ri certaines actions a droit de vote. Cette option ne parait pas avoir d'effet sign@catif sur la valeur estime'e relative des actions.

INTRODUCTION

Many corporations issue two classes of common equity which differ in their voting rights. In these cases the voting (V) common shares generally trade at a higher price than the restricted voting (RV) common shares. This phenomenon has been documented and investigated by researchers in at least five countries: Jog et al. (1985), Canada; Partch (1987) and Lease et al. (1983), U S ; Levy (1983), Israel; Rydqvist (1986), Sweden; and Megginson (1988), U.K. Outside of Canada, the only common difference reported between the two classes is the voting right. In a few cases these papers report some differences in dividends between the two classes, and in Sweden there may be differences in the right of foreign shareholders to own V shares.

*The authors wish to acknowledge helpful comments made by Gordon Roberts and an anonymous referee.

Levy finds a mean premium of 45.5% (i.e., the price of the voting share is 45.5% greater than the price of the RV share) in Israel. Megginson reports an average premium of 13.3% in the U.K. Lease et al. observed premia of 5.4% on average in the U.S. and Rydqvist finds average premia ranging from 2% to 6% year by year. In Canada the average premium varies from about 8% to 13% from year to year. In each of the studies, the price premia vary considerably between firms.

A variety of explanations have been advanced to explain these price premia and why they vary cross-sectionally. Rydqvist relates the cross-sectional differences in premia in Sweden to the concentration of ownership of the firm. In his model, different concentrations of share holdings lead to different values for a vote, and hence different premia for shares with different voting rights. Megginson relates the differences to the degree of insider ownership of the two classes of shares. The higher the concentration of insiders' equity in V shares, the higher the premium. Levy relates the

RCSAICJAS 9 DECEMBRE / DECEMBER 1990


differences to the probability that the V shareholders may participate in a takeover premium denied to the RV shareholders.

In Canada, V and RV shares may differ in several ways apart from voting rights. These differences may include different dividends, different payments in liquidation, and/or different rights to participate in takeover offers. (The ability or right of an RV shareholder to participate in a takeover offer for the V shares is defined in what is called a coattail provision in the Articles of Incorporation.) In some cases the V shareholders have the right to convert the V share into an RV share at any time. The only published research to investigate these differences in Canada is Jog et al. They perform an event study on the creation of the two classes of shares by a share split. The sample consists of 33 companies which split V shares into V and RV shares. They find that total shareholder wealth stays about the same if the RV shares are granted coattails, while it drops if no coattail is given to the RV shares. They also partition the sample between minority and majority controlled firms, but do not find a significant difference. Since their study examines total shareholder value, they do not draw any conclusions about relative price premia of V over RV shares, nor do they examine other characteristics of the shares.

In this paper we describe the different features of V and RV shares more fully and present empirical evidence on the effect of these features on the relative prices of 66 pairs of V and RV shares traded on the Toronto Stock Exchange. In particular, we test three hypotheses relating the size of the price differences to: 1 . Control: the existence of some individual or cohesive

group which has an absolute majority of the votes; 2. Coattail: the ability of RV shares to participate in

takeover offers; and 3. Convertibility: whether the V shares can be converted to

RV shares at the holder’s option. The rest of the paper is organized as follows. The next

section discusses the valuation effects of the features, and proposes the three hypotheses. Then we describe the sample selection, and the characteristics of the sample. Our empirical tests of the effects of the characteristics on the signs, and the three hypotheses about the size of the premia follow. We conclude with some brief comments about the results.

VALUATION EFFECTS OF V AND RV SHARE FEATURES

Canadian companies have created V-RV pairs with characteristics that differ between the two classes, and between companies. We discuss these features and their relative valuation effects under three headings: (1) voting rights; (2) explicit cash flows, including coattails and takeover premia, dividends and liquidation payments; and (3) convertibility of V to RV shares. The valuation effect is measured by a price premium defined as (Pv-PRv)/PRv, where PV and PRV are the prices of the V and RV shares.

Voting Rights Why should voting rights have value when the claims to

residual cash flows are identical? Rydqvist ( 1985) points

out that when shareholders disagree about the optimal investment, financing and dividend decisions of the firm, votes are valuable. Voting power enables the shareholder to have some say in these decisions. With enough votes one can ensure that his own optimal decision is the choice made.

The observed value of voting rights depends on the concentration of ownership. If a single person or company has an absolute majority of the votes (called majority control, henceforth), the entire value to voting belongs to that majority holder, because his decisions can always be enforced by majority vote. When we observe V shares trading on the market in this situation, we are observing shares traded between minority shareholders whose votes do not influence the firm’s decisions. If all the other factors were equal, the V shares should trade at the same price as the RV shares, since they would share identically in the cash flows. If the largest single shareholder has only a minority position (minority control, henceforth), then the other V shareholders may have some possibility of forming coalitions and influencing the firm’s decisions. This observation leads to our first hypothesis: H1 :The premium will be higher when the largest voting

holding controls less than a majority of the votes. Hypothesis HI assumes that the structure of ownership

does not change over time. In the case of majority control, the V shares held by outsiders not only have no voting value now, but they are not expected to have any in the future. The evidence is that the exact percentage of votes held by different shareholders does change from time to time for some companies, but the existence of majority control rarely changes.

The converse question is whether minority control can continue in equilibrium, given that there may be a value to moving to majority control. The evidence from our sample is that the minority holdings change into majority holdings infrequently, and almost always because of takeovers by outsiders.

Explicit Cash Flow Differences Takeovers and Coattails

An alternative explanation for the observed price difference between V and RV shares was advanced by Levy (1983). He pointed out that if someone wished to purchase control of a firm he need buy only the voting shares. The voting shareholders participate in any takeover offer but the RV shareholders do not.1 The value of this right to participate in a takeover premium will vary from company to company depending on the probability of a successful takeover and the expected takeover premium. The takeover premium is at least partly related to the value to voting explained in the previous section.

If the RV shares have a coattail provision, they too may participate in any takeover offer in which minority V shareholders can participate. In this event any price difference between the two classes of shares cannot be attributed to a potential takeover premium.* Since only about half of the RV shares have coattail provisions we can separate the portion of the premium attributable to a potential takeover from that due to the continuing value of voting control.

RCSAICJAS 10 DECEMBRE I DECEMBER 1990


The coattails have two basic forms. One form of coattail allows the RV shares to convert to V shares in the event of a takeover bid in which both classes are not offered the same terms. The other type of coattail changes each RV share to have the same vote as each V share in the event of a takeover bid in which the two classes are not offered the same terms. The two classes of shares, however, remain distinct. The number of RV shares outstanding is usually about the same or greater than the number of V shares outstanding. Occasionally, the number of RV shares is much greater. Thus, this voting change forces the takeover bidder to bid for the RV shares as well as the V shares if he is to gain control.

To the extent that the price difference between V and RV shares is based on an anticipated or potential takeover premium, the existence of an effective coattail provision should reduce the price difference. This yields our second hypothesis. H2 :The premium will be higher for companies which do

not extend coattails to the RV shareholders.

Dividends and Liquidation The majority of Canadian RV shares receive dividends

that are or may be greater than those paid to the V shares. A few companies give a preference in liquidation to one class of shares or the other. This liquidation preference is limited to a set dollar amount, after which the other class of shares get the same amount, and the two then share equally.3 These differences are always defined in the articles of the company and so are not discretionary. The value of differences can be estimated reasonably accurately. In some of our tests we make reasonable assumptions to allow us to adjust the premium for the effect of the dividend and liquidation differences, thus reducing the number of confounding factors.

Converti bi I i ty Some V shares are convertible at any time at the option

of the holder into the corresponding RV shares. (No RV shares have conversion rights, except as a coattail.) This conversion right has value if the cash flows to the RV share are or can be greater than those to the V share. The greater cash flows to the RV shares come from higher or potentially higher dividends, or from a liquidation preference. It may also be of value if the market for RV shares is more liquid than that of V shares. This gives our third hypothesis: H3 : The premium will be greater when the V shares have

the right to convert to RV shares.

SAMPLE SELECTION

We gathered daily prices for 1984 to 1987. Not all of the shares were listed for the entire period. Summary statistics reported in the paper relate to 1984 unless otherwise noted. Price pairs were gathered only for those days on which both the V and RV shares traded and the mean premium was calculated for each company for each year. Thin trading in the V shares was much more pronounced than in the RV shares. Three companies had no price pairs for 1984, and the share characteristics could not be obtained for one other company. Another company had only 3% of the V stock in public hands. We removed these companies, reducing the sample size to 66. Altogether, our sample includes over 40% of the RV shares listed at the time, and over 80% of the companies which listed both V and RV shares. The sample size declined to 63 in 1986 and 57 in 1987. All but one of the missing firms disappeared due to merger, bankruptcy or elimination of one of the share classes via a reorganization. We removed Lochiel from the 1986 sample because the prices dropped to $.l for the V shares and $.02 for the RV shares, giving unreasonable premia which biased the results. Lochiel liquidated in late 1986, with no payments to either class of shares.

We discarded the 1987 observations prior to May 4, a date about one week after the last appeal was exhausted in the Canadian Tire case (see footnote 2). This case had a major impact on the evaluation of all RV shares. We also omitted observations from Oct. 16 - 21 because the Toronto Stock Exchange announced that published price data was unreliable in that period. For 1984 - 86 the number of observations per company (i.e., price pairs for days on which both the V and RV shares traded) ranged from 5 - 252, with a median of 101. Only one company had less than 20 observations, and only in 1984. In 1987 we had 21 - 162 observations per company, with a median of 99.

We consulted a variety of public sources4 and corresponded with the companies to determine the ownership structure and the correct characteristics of each V and RV share regarding dividends, liquidation preference, takeover protection, election of directors and conversion option for our time periods.

SAMPLE CHARACTERISTICS

Dividends Four types of dividend rule exist. The types and their

frequency in our sample are shown in Table 1 . The commonest relationship is equal dividends, seen in 32 of 66 companies. The other rules all involve dividends which are sometimes or always greater for the RV shares. These are permanent differences in cash flow, in the sense that a higher dividend to an RV share relative to a V share is not -

we examined 71 companies with both and Rv shares listed on the Toronto Stock Exchange at December 31, 1984. About 75 more companies had only RV shares listed. Most of the companies in the sample are medium to large in size, with market capitalization ranging from $6 million to s2. billion. The only companies with capitalization less than $20 million are four oil exploration companies.

reversed by lower dividends to the RV share relative to the share later. Among shares with superior RV dividends, the most

common relationship is RV dividend equal to a constant multiple of the V dividend. A few companies in this category have never paid a dividend. This difference makes the RV cash flows a perpetual multiple of the V cash

RCSAICJAS 1 1 DGCEMBRE / DECEMBER 1990

EMPIRICAL EVIDENCE ON THE RELATIVE VALUATION ... ROBINSON &WHITE

flows.5 A reasonable approximation of the value of PVPRV due to dividend differences in this case is the ratio of the dividends .

Also fairly common is a non-cumulative partial preferential RV dividend. Once the RV share dividend (quarterly, semi-annual or annual, depending on the terms of the issue) reaches the level of the preference, then the same amount can be paid to the V shares. Thereafter, the two classes share equally in all dividends. The preference ranges from 1 cent to 60 cents p.a., with most firms giving a preference of 10 cents or less. Some companies set the preference amount so low that the dividends have always been equal, and the preference will probably never be invoked. Those RV shares which have a very small preference effectively receive the same dividends as the V shares. Thus, the RV shares would be valued at or very close to the value of the V shares, all else equal. For the others, a potential investor would have to estimate the expected future dividend differential. Since the absolute value of the preference is not very large in any case except one and the value of the preference will erode if the company’s dividends grow in nominal terms, the excess value to the RV share arising from this preference cannot be too large.6 I

Table 1

Types of Dividend Rules

Type of Dividend Equal Constant Proportion: I . 1 x

1.15 x 1.2 x

Partial Preference, effectively equal Partial Preference, not equal Constant Difference Combinations Total

32 1 1 5 8 9 8 2

66 -

The least common pattern is an RV share with a dividend which is a constant amount greater than the V dividend. The additional amount is quite small, ranging from 1 cent to 10 cents p.a. Since the amount is fixed in nominal terms, the ratio of the RV dividend to the V dividend will approach 1.0 over time as nominal earnings and dividends rise.

In addition to these three patterns, combinations are possible. Maclean Hunter pays the RV shares the lesser of 1 . 2 ~ the V dividend and the V dividend plus 5 cents. Consumers Distributing pays 1 . 1 5 ~ the V dividend up to 20 cents on the V dividend, after which the V dividend increases to become equal to the RV dividend for dividends of 23 cents and higher.

Liquidation In our sample, five companies give liquidation

preferences to the RV shares ranging from $0.05 to $7.50 per share. Unicorp gives preference to the RV shares to the

extent of paid-up capital, which was $6.01 at the end of 1985. After this amount is paid to the RV holders, the V holders get their paid-up capital back, which was $1.79 at the end of 1985. Thereafter, the two classes share equally. Consumers’ distributing gives a $0.05 per share preference in liquidation to the V share.

The effect of such liquidation preferences on the value of the RV shares is likely to be very small. It depends on the probability of liquidation, the length of time until it occurs, and the probability that the firm’s net assets after paying creditors will cover the liquidation amount without also providing enough for an equal payment to the V shares. Companies of the size required for a TSE listing rarely liquidate voluntarily, and those which are forced to liquidate will not likely have enough assets to pay even creditors and preferred shareholders.

Convertibility of V to RV Shares The V shares were convertible into RV shares in 43

cases. For 24 of these firms the RV shares had some sort of superior or preferential dividend. However, in 7 of these the preference was so low that the dividends on the two classes of shares were effectively equal. No company granted both a conversion right to the V share and a liquidation preference to the RV share. Thus, in 17 cases dividend differences give a clear value to the conversion option. In 7 other cases dividends provide potential (though small) value to the conversion option. For the remaining 19 cases the conversion right is valuable only in that the market for RV shares is more liquid.

Coattails Our 1984 sample included 35 RV shares with coattails,

31 without. All RV shares whose initial listing on the Toronto Stock Exchange occurred since 1984 have coattails.

Voting Rights and Control Blocks Table 2 shows the distribution of voting blocks for the

sample, both by number of votes held by the largest single shareholder or voting trust, and by the five largest shareholders combined. In about half the cases an absolute majority is vested in one person, company or voting trust. This may understate the number of cases in which there is an effective majority, since i t ignores family voting preferences. Since family divisions are not uncommon we opted to treat these family holdings as separate holdings, unless a voting trust existed.

One other factor which could affect the value to voting is the degree of restriction on the RV shares. If the difference in votes per share between V and RV shares is small we would not expect to observe a significant premium. Table 2 also shows the distribution of relative voting power. In no cases is the voting difference between the two classes trivial. Effectively, then, any votes attached to RV shares are worth very little.

A SIGNS TEST Using the preceding discussion of the valuation effects of

the different characteristics, we can form expectations about

RCSAICJAS 12 DECEMBRE f DECEMBER 19901990

EMPIRICAL EVIDENCE ON THE RELATIVE VALUATION ...

Votes per RV share Votes per V share

Number of companies

ROBINSON & WHITE

0 1 1 1 1 1 1 1 5 10 20 25 100 500

51 1 6 2 1 4 1

Table 2

Ownership and Voting Characteristics

(a) Voting Control Position By Number of Votes

W

0 0 0 0 + + + +

Mean Std. Dev Median Minimum Maximum First Quartile Third Quartile Number of Companies with:

majority control ( > 50%) minority

Premium No Conversion Conversion

0 0 0 ? + or 0 + + ? + or 0 + + ? + or 0 + +

-

~~

Largest Single Vote Block

44% 18.7%

46 % 13 % 83 % 29 % 56 %

30 36

(b) Relative Number of Votes Per Share

5 Largest Voting Blocks Combined

56 % 16.9%

55 % 21 % 91 % 49 % 68 %

45 21

the sign of the premium for most of the V-RV pairs, and then examine the observed signs. The expected effects of the different characteristics on the price premium are summarized in Table 3. Panel (a) enumerates the effects of cash flow and control difference independently. The absence of a coattail lowers the value of the RV shares relative to the V shares while dividend or liquidation preferences raise it. If no one has a majority of the votes the value of the V share should be higher than that of the RV share. The expected effects of combinations of the characteristics are shown in panel (b) of Table 3. In some cases the combined results are uncertain since different factors operate in opposite directions. This uncertainty is eliminated if the V shares are convertible into RV shares. In this case arbitrage ensures that the price of the V share cannot be less than that of the RV share. If the V shares are not convertible, then the column labelled “No Conversion” shows the expected combined effect of cash flow and voting value on the premium. If they are convertible, then the “Conversion” column shows the expected premium for all three characteristics combined.

For an example of how to read the table, consider a company whose RV shares have no coattail, but are paid a dividend 1.1 times the V dividend. One person holds 40% of the V shares, with the rest widely-held. The V shares may be converted to RV shares at the holder’s option any time. First, observe the cash flow difference in panel (a). The dividend favours the RV shares, but the lack of a coattail gives the V shares the possibility of excluding the

Table 3

Expected Sign of the Premium (a) Share Characteristics and Their Effects

Implied Premium Possible Characteristics

RV has dividend or 1. Cash Flow (CF): RV has Coattail liquidation preference

Yes Yes Yes No No Yes No No

2. Value of Vote (VV): Majority control Minority control

- 0 ? + 0 +

(b) Combinations of Characteristics

CF

- 0 ? + 0 ? +

RCSNCJAS 13 DECEMBRE / DECEMBER 1990


+ 0 -

Actual Sign

Table 4

Hypothesized Sign Row total

? - + + o r 0 0 22 10 8 2 2 44

5 1 5 1 2 14 3 2 I 0 2 8

ROBINSON &WHITE

+ 0

Column Total

Actual Sign -

Signs Test

Comparison of the expected and actual sign of the premium. The average of the observed values of the premium for each company is categorized according to the expected relationship, based on the characteristics of the shares and the potential value of votes.

Hypothesized Sign Row total ? - + + o r 0 0

25 10 7 2 2 46 1 0 4 0 2 7 2 1 0 1 0 4

28 I 1 I 1 3 4 57

13 I 30 Column I Total 14 3 66

Correctly classified: 38/60 = 63% Incorrectly classified: 22/60 = 37 % Indeterminate: 6

(b) 1987, May 4 - Dec. 31. The number of observations per company ranges from 21 - 162, with a median of 99.

Correctly classified: 40153 = 75% Incorrectly classified: 13/53 = 25 % Indeterminate: 4

RV shares from a takeover premium; thus, the implied premium is uncertain (‘?’). The value to voting implies a positive premium (‘+’) because the firm is minority- controlled. In panel (b) we see a ? under CF and a + under VV on line 7. The combination could produce a positive, negative or zero premium, giving an uncertain (?) if the V shares are not convertible. Since they are convertible in this example, arbitrage should force a non-negative (+ or 0) premium.

Table 4 shows a comparison of our expectations of the sign of the premium and the average observed premium for 1984 (Panel (a)) and 1987 (Panel (b)). Table 4 is organized like a discriminant analysis classification matrix. Across the top the expected relationship is shown, and along the side the observed relationship. For each pair of stocks, the observed values are measured by averaging the premium for all days on which both classes traded. The average premium is considered to be positive or negative only if a t-test that it is equal to zero can be rejected at the 99% confidence level.7 The entries in the cells give the number of companies each category.

The results are for 1984 are mixed. The observed relative prices are consistent with our expectations only 63% of the time that the expectations are defined. Pearson’s chi- squared test cannot reject the hypothesis that there is no

relation between expectation and observation (chi-squared = 8.12, Prob. = 0.42).8 Thin trading does not appear to be the cause of the misclassifications as most of the misclassified companies had over 30 observations.

Since 1984 there has been increasing attention paid to RV shares by the investment community. The Canadian Tire episode of 1986-87 attracted widespread publicity. We repeated the analysis of Table 4 for 1985 and 1986 with essentially the same results as in 1984. The results for May 4 - December 31, 1987, presented in Panel (b), show some improvement. Correct classifications occur in 75% of the cases. Pearson’s chi-squared test rejects the hypothesis that there is no relation between expectation and observation (chi-squared = 18.7, Prob. = .02), but the small cell sizes make this result unreliable.9

Some of the discrepancies between our expectations and the observations are easily explained. A positive premium where no premium is expected, or a zero premium where a negative premium is expected may be a result of anticipated change in ownership. That is, investors may expect the majority control position of the companies to dissolve into minority contro1,lO creating value for the votes in the future. Also, if the coattail was not seen to be completely effective, then these unexpected positive premia are justified.


EWIRICAL EVIDENCE ON THE RELATIVE VALUATION ...

1985 .lo9 .173 66

1.048

-.lo9

.052

44 12 10

ROBINSON & WHITE

1986 .131 .230 63

1.147

-.089

.046

45 1 1 7

The observed zero premia where positive premia were expected can be explained by the reverse argument. We define majority control as a single person or voting trust with over 50% of the votes, but some families or groups vote together on every issue, which makes the votes of the V shares held by non-group members worth much less. There seems no objective way of determining when this does or does not occur.

The unexpected negative premia are more difficult to explain. An optional feature such as a vote can never detract from value, and these cases featured no cash flow advantage to the RV shares. The only apparent explanation is liquidity, since the RV shares always trade more heavily.

Non-synchronous trading is unlikely to seriously prejudice our results. The price of the more heavily traded share in each pair (always the RV share) will on average be observed later in the day than that of the less heavily traded stock. Since returns are positive on average, stock prices tend to rise over time. This will bias the results, causing PRV to be overstated relative to PV on average. However, since each price pair has both observations drawn from the same day the bias in the premium should not exceed the average one day return on the RV share. This is unlikely to exceed 0.1 %.

A more serious problem caused by non-synchronous trading is that variability of the observed premia is increased. This makes it more difficult to distinguish stocks which have a small positive or negative premium from those with no premium. The existence of a bid-ask spread has the same effect.

EVIDENCE ON THE SOURCES OF THE PREMIA

In this section we wish to determine what impact the various features (apart from dividend differences) of the V - RV pairs has on the size of the premium. Since the relative prices of the two classes of stock will be affected by differences in dividends and liquidation payouts we first adjusted the premia to correct for these differences. The actual adjustments are described in the Appendix.

Table 5 displays summary statistics of the adjusted premia for 1984 - 87. The median premia lie between 4% and 12% while the means are between 8% and 13%, except in 1987. The very large mean premium in 1987 is caused by four companies which had very large premia. Except in 1987, the mean adjusted premium is consistent with the results of Megginson (1988) for the U.K and Lease et al. (1988) for the U.S.11 Since any dividend preferences favour the RV shares, the adjustment lowers the price of the RV share and raises the premium. Thus, the adjusted premia are higher than the corresponding unadjusted premia.

As we have hypothesized already: H1: The premia to the V shares will be higher when the

largest single voting holding controls less than 50% of the votes.

H2: The premia to the V shares will be higher for companies which do not extend coattails to the RV shareholders.

H3: The premia to the V shares will be higher when the V shares have the right to convert to RV shares.

Each of these has a corresponding null hypothesis that the premia are not larger when the hypothesized condition holds.

H01: The premia to the V shares will not be higher when the largest single voting holding controls less than 50% of the votes.

H02: The premia to the V shares will not be higher for companies which do not extend coattails to the RV shareholders.

H03: The premia to V shares will not be higher when the V shares have the right to convert to RV shares.

Table 5

Price Premia By Year The premium is (Pv-PRv)/PRv adjusted for differential dividends and liquidation rights.

Mean Standard Deviation N

Maximum

Minimum

Median

Number which were: Positive Zero Negative

1984 .084 .122 66

.704

-.133

.054

44 14 8

1987 .233 .402 57

2.049

-.I13

.118

46 7 4

The three hypotheses produce eight possible combinations of characteristics. Table 6 lists the frequency with which each combination occurs in our sample. Because the frequencies of the combinations are not all the same it is not possible to do an analysis of variance.

Table 6

Distribution of Characteristics

The number of firms which have majority control, a coattail provision or have V shares convertible into RV shares.

Majority Control

Yes Yes Yes Yes No No No No

Coattail

Yes Yes No No Yes Yes No No

Yes No Yes 10 No

66

* 1985 12 4 6 10 15 4 10 5 66 - -

of Firms iisliii

10 5 5 63 57 - -

RCSAICJAS 15 DECEMBRE DECEMBER 1990


Year Characteristics Mean Difference

1984 Coattail -0.020 Conversion 0.006

Ownership 0.070

ROBINSON & WHITE

F-Statistic Probability > F 5.50 0.02 0.35 0.55 0.01 0.93

Table 7

Explanatory Power of Share Characteristics

1986

1987

A regression to determine the effect of each characteristic on the mean premium paid for a voting share. The column head Mean Difference gives the difference between the means of the two subgroups for the characteristic. The differences are calculated so that a positive result is expected. (Minority control, absence of a coattail, and/or the option to convert V shares into RV shares are expected to generate a positive difference.)

The column headed F-Statistic gives the ratio of the variance explained by that characteristic to the residual variance unexplained by all other characteristics. The final column gives the probability of observing an F-Statistic that large or larger by chance.

Ownership 0.147 6.96 0.01 Coattail -0.089 2.50 0.12 Conversion 0.018 0.09 0.76

Ownership 0.060 0.29 0.59 Coattail -0.002 0.00 0.99 Conversion 0.154 1.59 0.27

(a) All Firms

Coattail Conversion Coattail Conversion Coattail Conversion

1984

1985

1986

0.042 2.22 0.15 0.052 3.30 0.08

0.063 1.94 0.17 0.024 0.27 0.61

0.045 2.70 0.11 0.015 0.30 0.59

Ownership Coattail Conversion

Coattail Conversion 1987

0.100 -0.003 -0.025

0.289 7.61 0.01 0.165 2.44 0.13

5.52 0.00 0.28

0.02 0.95 0.60

(b) Majority Controlled Firms Only

To test the hypotheses we regress the observed premium against three dummy variables representing the three characteristics. The significance of each characteristic in explaining observed premia is measured by the reduction in the residual sum of squares when this variable enters the regression last. This procedure treats all characteristics symmetrically. It is the same as an analysis of variance when the frequencies of all combinations of characteristics are equal.

The results of the analysis are shown in Table 7, Panel (a). This table shows the difference in the mean premium paid for voting shares, and its statistical significance. The difference is found by partitioning the sample by the characteristic and taking the difference between the mean

premium in each subset. Differencing is done in such a way that a positive result is expected. (For example, the difference given for the Majority Characteristic is the mean premium for minority controlled companies less that for majority controlled companies.)

The only characteristic which is statistically significant is whether or not the company has a shareholder who has majority control. This is significant at the 5% level in three of the four years and becomes not significant after resolution of the Canadian Tire affair. If the firm has a majority owner, the premium paid for voting shares is significantly lower than otherwise. Thus, we reject the null hypothesis HO 1 in three of the four years.



There is considerable cross-sectional variation in the premium paid for voting shares in firms without majority control. It has been suggested that this is a result of the varying concentration of voting power in these firms. (see Rydqvist (1983, or Robinson and White (1989)) This large cross-sectional variation in premia within the non-majority controlled firms may be masking the effect of the coattail and the conversion option. Further, if there is a spurious relation between the concentration of voting power and the existence of the coattail this may explain the anomalous results observed for the coattail.

In order to correct for this possibility we perform the regressions on the subset of firms with majority control. For these firms the impact of voting power is less ambiguous. Voting shares outside the control block have essentially no power. Thus, observed premia should be more clearly attributed to the other characteristics of the shares.

The results of these regressions are shown in Table 7, Panel (b). Neither coattail nor conversion has a significant influence in 1984 - 86; however, the signs are at least correct. The coattail becomes significant at the 99% level in 1987, after the resolution of the Canadian Tire case confirmed the enforceability of that feature. The conversion option remains insignificant.

In summary, we reject Ho1: no effect of ownership, for 1984-86, but fail to reject it for 1987 after the Canadian Tire decision. We fail to reject H02: no effect of coattails, until 1987. We fail to reject H03: no effect of conversion option, for all years.

revealed that there was conflict between the family members who owned the majority of the voting shares. Prior to this the family had always voted as a block and indeed, for a time, the shares were held in a voting trust.

The sum of these events demonstrated several possibilities. Voting shareholders might attempt to expropriate RV shareholders. Voting trusts could break up, or single controlling shareholders die and leave their shares to several hostile parties. Coattail provisions may prove to be ineffective. The varying likelihood of these sorts of events introduces so much cross sectional variation into the premia paid for voting shares that the differences between majority and minority controlled firms are no longer statistically significant. At the same time, the resolution of the Canadian Tire case has reinforced the value of coattail protection in majority controlled firms.

Although we have had some success in explaining observed premia, the variation in the premia between companies is very large, and is not just the result of the four factors we have examined. We would expect that other missing variables include the probability of takeover, and the cross-sectional differences in values which controlling shareholders can extract from different companies. Research which can more explicitly model these two factors would not only improve our understanding of the relative valuation of V and RV shares, but also our ability to investigate the broader topic of corporate control and behaviour of owner-managers.

NOTES CONCLUSIONS

Four characteristics of voting and restricted voting pairs of shares may affect their relative valuations: 1. Different dividends and/or different liquidation rights.

2. The potential value of the vote.

3. Takeover participation for the RV shareholders (coattail).

4. The right of some V shares to convert to RV shares.

We take it as self-evident that the cash flow differences in 1. affect value, and we adjust for them in order to examine the other three characteristics. The conversion feature has no significant value, probably because most voting shares are more valuable than the corresponding RV shares for other reasons. The value of the vote is significant until 1987 when it becomes statistically insignificant. At the same time the coattail provision becomes a significant explanatory variable for majority controlled firms.

We suggest that this change in 1987 occurred because the market started to assess ownership behaviour differently at this time. Prior to 1984, non-voting shares did not receive much scrutiny. From 1984 to 1987 there was increasing concern about the rights of the holders of restricted voting shares. This was accentuated by the highly publicized attempt by Canadian Tire to overcome an existing coattail provision. The publicity surrounding this attempt also

I.

2.

3.

4.

5 .

17

In most jurisdictions an offer to buy a majority of a class of shares must be made equally to all holders of that class. For example, the Ontario Securities Act (s. 91). which governs transactions on the Toronto Stock Exchange where the companies in our sample are listed, requires follow-up offers to all owners of a class of securities if any owner is paid a premium greater than 15% above market price. There are exceptions, but they are not common. Since rakeover bidders usually offer to pay more than the current market price, the opportunity to participate in such an offer is valuable. A coattail may not offer perfect protection. It may not allow the RV shareholders to participate in any premium that an individual who already has a block of V shares may pay to increase the size of his block, perhaps to the point of absolute control. It may also fail to operate if the controlling shareholder has placed his shares in a holding company and transfers control of the holding company instead of selling the shares directly. One important episode testing the coattail occurred in 1986-87 with respect to the control of Canadian Tire. The three family members who owned 61% of the V shares found an apparently legal method of circumventing the coattail attached to the RV shares and agreed to sell enough V shares to a dealer group to transfer control of the company. The effect of the transaction was to give a premium of over IOOO% for 49% of the V shares (that is, the dealers would bid for only 49% of the shares and take up shares tendered pro rata). Since the dealers already held 17% of the V shares. this arrangement would confer absolute control. No offer was made to the RV shareholders, who had no votes, but held 96% of the equity of the company. The Ontario Securities Commission did not rule on the strict legality of the transaction, but prevented it using broader grounds under its mandate to regulate the fairness of securities markets dealings. Two appeals of the OSC decision, culminating in an appeal heard by the Supreme Court of Ontario, supported the OSC’s discretionary power to make usch a ruling. This series of decisions was a significant signal that the OSC could enforce coattails on behalf of shareholders based on the understood intention of the coattail, rather than the strict wording of the articles of incorporation. This preference does not appear to apply to reorganization, but no event involving invocation of a liquidation preference has occurred to provide empirical evidence, to our knowledge. Annual reports, prospectuses, information circulars and three Maclean Hunter publications: The Financial Post Top 500, Survey of Industrials, Survey of Mines and Energy Resources. The only exception to this occurs in the case of a successful takeover bid for both

RCSAICJAS DECEMBRE I DECEMBER 1990


classes, which would usually occur at the same price for each class. Silcorp has a preference of 60 cents, but has usually paid at least that to both classes. The next highest are Heritage Group and Chum at 24 cents, and both of them have been paying higher dividends to both classes for several years. We obtained the same results using a non-parametric sign-rank test to determine whether the premium is significantly different from zero. The premia are approximately normally distributed. although they are discrete, not continuous. because prices differ by discrete amounts, usually $0.125. We also performed the same analysis on all observations (n=7882) instead of company averages. The proportion correct is 61%. and we can reject the hypothesis of no relationship between expectation and observation (chi-squared = 481, Prob. = 0.00). The test using only companies may be unreliable due to the small cell sizes, while the test on all observations may suffer from lack of independence between observations. See fn. 8. For all observations, the correct proportion was 66%. and the hypothesis of no relationship was rejected (chi-squared = 233, Prob. = 0. 00 ).

10. Either the death-of a controlling shareholder and distribution of the shares under his will, or dissolution of a voting trust could create a minority control situation.

11. These adjusted premia are the numbers quoted in the Introduction for comparison with the results in other countries. This seems appropriate because dividend and liquidation differences are rarely observed in other countries.

REFERENCES

Jensen, M.C. and W.H. Meckling (1976), “Theory of the firm: Managerial Behavior, Agency Costs, and Ownership Structures”, Journal of Financial Economics, 3 305-60.

Jog, Vijay, Alan Riding and Paul Seguin. “Shareholders’ reactions to Issuances of Restricted Voting Common Stock”, Administrative Sciences Association of Canada 1985 Proceedings. Finance Division, ed. William Rentz, 10- 18.

Lease, R., J., McConnell and W. Mikkelson (1983). “The Market Value of Control in Publicly-traded Corporations”, Journal ofFinancial Economics 1 I 439-7 I .

Levy, Haim (1982). “Economic Evaluation of Voting Power of Common Stock“, Journal ofFinonce, 38 80-93.

Maclean Hunter (1984-87). Survey oflndustrials. Toronto, annual editions. Maclean Hunter (I 984-87), Survey if Mines and Energy Resources, Toronto, annual

editions. Maclean Hunter (1983, 1984, 1985, 1987), The Financial Post Top 500. Toronto,

annual editions. Megginson, William L. ( 1 9 8 0 “Restricted Voting Stock. Acquisition Premiums and

the Market Value of Corporate Control”. presented at the Western Finance Association annual conference. Napa.

Partch, M.M. (1987), “The Creation of a Limited Voting Common Stock and Shareholder Wealth”, Journal if Financial Eciinomics I8 3 13-40,

Robinson, C. and A. White (1988). “The Value of a Vote in the Market for Corporate Control”, presented at the Western Finance Association annual Conference, Napa, Ca.

Rydqvist, Kristian, (1985) “The Pricing of Shares with Different Voting Power and the Theory of Oceanic Games” unpublished dissertation, The Economic Research Institute at the Stockholm School of Economics.

APPENDIX

Adjustment of Price Premia for Dividends and Liquidation Preferences

To adjust observed prices for explicit cash flow differences we model the share price as the sum of an

economic component (the present value of dividend and liquidation payments), and another component (attributable to other cash flows, such as the right to participate in a takeover bid). Thus,

where E denotes the economic component, and X and Y denote the other components. The price premium is then

x - Y - EV - ERV PV - PRV pRV pRV ’RV

+- -

and the portion of the premium which is of interest is

-- X - Y PV-PRV EV-ERV - pRV pRV pRV

RV dividends which are a constant proportion of the V dividend are assumed to be perpetual. Thus

and the adjustment to the observed premium is

EV - ERV ~ EV - E R ~ - - -- - 1 . DV pRV ERV DRV

RV dividends which exceed V dividends by some non- proportional amount imply

EV - ERV = - Present Value (Dividend Difference).

and the premium adjustment is - Present Value (Dividend Difference)/PRV.

Where the difference was a constant amount it was treated as a perpetuity. Otherwise the average historical dividend difference was treated as a perpetuity. The discount rate used was lo%, approximately the yield on preferred shares. The additional dividend never exceeded 0.5% of PRV so this adjustment never changed the premium by more than 5%. It is not particularly sensitive to the discount rate used.

The adjustment for any liquidation preference is the expected present value of the preference dividend by PRV. In all cases either the preference or the probability of liquidation is negligible.


empirical evidence on the relative valuation of voting and restricted voting shares

Documents