To Grow or Not to Grow. That is the Question.

THE FEAR OF LOSING CONTROL OF THE FAMILY BUSINESS SLOWS BOTH INVESTMENT AND RAISING NEW CAPITAL. AN ONGOING STUDY DEMONSTRATES THE EFFECTIVENESS OF THE INTRODUCTION OF TVRS, VOTING RIGHTS BASED ON THE OWNERSHIP OF SHARES, AND PROVIDES IMPORTANT INDICATIONS TO REGULATORS WHO ARE DISCUSSING THE ADOPTION OF CEMS, MECHANISMS FOR STRENGTHENING CONTROL

by Claudia Imperatore, Assistant Professor of Accounting

Family-controlled and founder firms are common and economically important in several countries around the world. In the U.S. families control more than 55% of public firms. In continental Europe, the percentage is even higher, especially in countries such as Italy, Spain, and France. A key challenge for family owners and founders is the so-called “control vs growth dilemma”: as outside investment can dilute family control, family owners might prefer to under-invest and forego valuable growth prospects. A potential solution to this dilemma is the adoption of control-enhancing mechanisms (CEMs) (e.g. dual-class shares, shareholders’ agreements, pyramids) that enable family owners and founders to raise new equity and invest without relinquishing control. Alphabet, Facebook, and Lyft are just some examples of firms that adopted this strategy at the moment of their IPO. Yet, the implementation of CEMs is controversial as dominant owners, like the family, can use them to consolidate their control at expense of minority shareholders. Indeed, CEMs represent a deviation from the optimal corporate governance principle of one share – one vote. Given that, their introduction is under debate in many countries. After having lost the listings of local firms such as Alibaba, the Hong Kong Stock Exchange and Singapore Stock Exchange have recently changed their rules to allow dual-class structures of IPO firms. In Europe, an increasing number of countries are introducing tenure-voting rights to incentivize founder- and family-controlled firms to go public and raise external equity.

Following this trend worldwide, the Italian regulator introduced tenure-based voting rights (TVRs) in 2014 with the D.L. 24 June 2014, n. 91 (Competitiveness Decree). TVRs adoption is not mandatory as firms voluntarily introduce them through a modification of corporate charter that has to be approved by the AGM with a qualified majority of two-thirds. Notably, Italian TVRs are not a distinct class of shares, but rights that any shareholder can obtain if they hold the shares for at least two years, and are lost if the shares are sold or transferred. In the period 2015-2019, 49 listed Italian companies adopted TVRs with a positive trend over time. The majority of them are family firms with a relatively fragile control (i.e., family ownership lower than 50%).

Notwithstanding the concern that family owners can use TVRs to enhance their control at the detriment of minority shareholders, in the study “Do tenure-based voting rights help mitigate the family firm control-growth dilemma?” with Prof. Peter F. Pope (Bocconi University) we find that family firms with TVR under-invest less and raise more external equity. Because TVRs strengthen the family control over the firm, family owners are less reluctant to invest and raise new equity. Thus, TVRs can be an effective tool to solve the “control-growth dilemma” and foster investment in family firms.

Notably, we document that family owners use TVRs to pursue profitable investment as firm value is higher after family firms adopt TVRs. Above all, family firms with TVRs distribute more dividends and increase the percentage of directors representing minorities on the board of directors. Anticipating that TVRs may dissuade outsiders from supporting their strategic choices, family owners use mechanisms like greater dividend payout and stronger board representation to attract and persuade outsiders to invest in their firms. Hence, although TVRs imply a deviation from the one share-one vote principle, outsider investors can also benefit from their adoption. This is important for regulators that are currently discussing the adoption of CEMs: the benefits of CEMs hinge upon the extent to which CEMs expose minorities to the risk of being exploited by dominant owners. This risk is reduced in the case of Italian TVRs as they need to be approved by a qualified majority and any shareholder can obtain double voting rights as long as the holding requirement is met. As a result, the TVRs’ adoption is beneficial for both family owners and outsiders.