Dual-class firms’ choice of performance measures in CEO stock compensation contracts

Ji Li (Department of Accounting and Finance, California State University Bakersfield, Bakersfield, California, USA)
Yuhchang Hwang (Department of Finance and Accounting, China Europe International Business School, Shanghai, China)

Review of Accounting and Finance

ISSN: 1475-7702

Publication date: 12 November 2018

Abstract

Purpose

The purpose of this paper is to provide new evidence on the choice of performance measures used in dual-class firms to incentivize CEOs.

Design/methodology/approach

This paper uses coarsened exact matching and propensity score matching to match the dual-class firm sample with a control group of single-class firms. This study uses matching estimators to provide an analysis of how a dual-class structure affects the design of performance measures in performance-based stock awards. In addition, regression models are used to investigate the effect of a dual-class structure on performance measure choices.

Findings

This paper finds that market-based metrics are less likely to be used by dual-class firms relative to single-class firms. In addition, peer-based measures are much less common for dual-class than single-class firms. This study also finds that the length of the CEO’s performance evaluation period does not differ between dual-class and single-class firms.

Research limitations/implications

This paper attempts to investigate the choice of performance measures to find out the extent to which the board of directors focuses CEO efforts on firms’ long-term versus short-term objectives.

Practical implications

The findings reveal the relationships between the dual-class stock structure and the contractual features of CEO performance-based stock awards, provide empirical evidence for the company’s compensation committee and provide implications for the evolving practices of performance measures regarding CEO stock compensation. The findings are also useful to regulators, compensation consultants and firms pursuing efficient design of executive compensation.

Originality/value

This paper is among the first to study the determinants of compensation contracts. Second, prior literature seldom controls for CEO stock ownership, but this study matches dual-class firms to a control group of single-class firms that are similar in terms of CEO stock ownership and other important firm characteristics. Finally, these findings suggest that dual-class firms shield their executives from short-term market pressures and design stock compensation contracts that deemphasize volatile stock prices.

Keywords

Citation

Li, J. and Hwang, Y. (2018), "Dual-class firms’ choice of performance measures in CEO stock compensation contracts", Review of Accounting and Finance, Vol. 17 No. 4, pp. 540-562. https://doi.org/10.1108/RAF-09-2016-0133

Download as .RIS

Publisher

:

Emerald Publishing Limited

Copyright © 2018, Emerald Publishing Limited


1. Introduction

A large stream of academic work has examined the effect of dual-class structures on firm value and performance[1]. Some studies find that the separation of ownership and control inherent in dual-class structures leads to lower firm value and poor performance (Gompers et al., 2010), while there is also evidence suggesting that dual-class structures enhance firm value (Dimitrov and Jain, 2006). Numerous high-profile companies have chosen a dual-class stock structure in recent years – underscoring the importance of the issue in practice. Institutional investors, especially, have been concerned about multiple classes of stock with disparate voting rights, and complain that dual-class stock companies limit their ability to press boards and executives to institute real changes (Byrd, 2012; Appendix 1). In contrast, dual-class companies argue that their structures allow them to more effectively focus on long-term value creation (Appendix 2).

This study revisits this question by looking at the design of executive compensation and provides new evidence on the choice of performance measures in dual-class firms. The choice of performance measures is informative about intentions of the board of directors and about the extent to which CEOs are incentivized to focus on firms’ long-term versus short-term objectives. In this regard, CEO stock compensation arrangements provide an ideal setting to examine the purpose of dual-class stock structures.

There are two main theoretical explanations of dual-class structures. On the one hand, the managerial power theory holds that dual-class structures misalign economic incentives and voting power and thus disadvantage outside shareholders (Bebchuk et al., 2002). On the other hand, optimal contracting theory holds that adoption of a dual-class structure allows managers to enhance shareholder value over the long-run (Core and Larcker, 2002; Amoako-Adu et al., 2011). Specifically, it asserts that outside shareholders face information asymmetry about the firm and are unable to make informed choices about strategic initiatives. In contrast, company founders or other insiders of dual-class firms are able to innovate and exploit long-run product cycles for the benefit of shareholders. Firm value suffers if insiders are subjected to short-term market pressures. Thus, company founders or other insiders are said to need more voting power to better exploit their private information for the benefit of all shareholders.

To the extent that the optimal contracting view holds, performance measures in executive contracts of dual-class firms are expected to reflect long performance evaluation horizons, which incentivizes CEOs to focus on strategic initiatives and shield them from short-term market pressures. In contrast, if executives self-servingly influence the design of compensation contracts and dual-class structures facilitate managerial entrenchment, performance measures are expected to have a short horizon. Short-term performance measures are more easily controlled or manipulated by executives and thus should lead to higher compensation.

Several characteristics of performance measures in CEO stock awards are examined to empirically operationalize performance evaluation horizon. Specifically, measured are the length of the performance evaluation period, the use of stock-based measures, and the use of peer-based measures. Furthermore, focus is put on the choice of performance measures in stock awards as opposed to other compensation components for the following reasons. First, stock awards account for a considerable share of executives’ total compensation and thus are economically significant to both the firm and the CEO. Evans et al. (2018) document the rapid growth of performance-based equity awards in recent years. They record the proportion of companies granting performance-based equity awards increased from 47.4 per cent in 2009 to 68.3 per cent in 2013, and their fair value as a percentage of total CEO compensation increased from 33.6 per cent in 2009 to 37.1 per cent in 2013 in S&P 1500 companies. The growing economic significance of performance-based stock awards makes it meaningful to examine the performance measures used in these grants.

Second, unlike cash bonuses or salary, which are backward-looking and short-term oriented, stock awards spanning multiple years are supposedly for long-term incentive purpose and are forward-looking. Stock is a very long-lasting instrument for an issuer (Johnson, 1999). Companies granting stock awards is an important method to increase CEO’s ownership and thus to align CEO’s economic benefits with the company’s economic interests, consistent with agency theory. CEO performance is evaluated over multiple years in CEO performance-based stock awards, so the board of directors aims to incentive CEO to improve company performance in a long term, and thus performance-based stock awards are forward-looking oriented. When CEOs receive stock compensation, especially vested stock awards, multiple years’ performance of CEO is evaluated. Therefore, from this angle, performance-based stock awards granted based on multiple year performance are for long-term inventive purpose and thus are forward-looking oriented. In practice, companies are using performance-based stock compensation to incentivize CEO in a long-term and forward-looking orientation. For example, a key feature in Morgan Stanley CEO compensation program is that Morgan Stanley awarded performance-vested long-term equity incentive compensation based equally on target average ROE and total shareholder return relative to the S&P 500 Financials Index over three years (Cohen, 2017). In 2016, 72 per cent of CEO compensation was deferred, and 39 per cent of deferred compensation were linked to future performance.

Data on CEO compensation contracts are hand collected from proxy statements filed with the SEC from 2007 to 2011 for all USA dual-class firms in the S&P 1500 to assess whether dual-class firms choose performance measures differently than do single-class firms. Due to increased firm disclosure requirements implemented by the SEC in 2006, it is feasible to use this data to examine contractual features of performance measures in executives’ equity awards, particularly performance-contingent equity awards[2]. Such contract features include the length of the performance evaluation period, whether the specific performance metrics employed are stock-based, and the use of absolute or relative benchmarks (RPE). The main sample consists of 419 USA dual-class firms and a matched control group of single-class firms.

The main findings are as follows. First, market-based metrics are less likely to be used by dual-class firms relative to single-class firms: 37.1 per cent of single-class firms in the sample use market-based metrics, while only 8.8 per cent of dual-class firms use them. Second, peer-based measures are much less common for dual-class than single-class firms. In particular, only 6.9 per cent of dual-class firms use peer-based metrics as compared to 26.4 per cent of single-class firms. The findings suggest that adoption of a dual-class structure is consistent with shielding CEOs from short-term market pressures with regard to their long-term strategic business decision-making. Avoiding the use of stock-based measures reduces the pressure on CEOs to meet quarterly earnings targets and to manage analysts’ quarterly forecasts. Similarly, avoiding the use of peer-based metrics alleviates the pressure to compete with peers that may be overly focused on pursuing short-term stock returns.

The results contribute to prior literature in three ways. First, while prior compensation studies have focused on the consequences of compensation contract choices, such as the comparison of total compensation amount in dual-class firms with the total compensation amount in single-class firms, far less work has been done to study the determinants of compensation contracts. This study fills in this void and highlights that the choice of single- versus dual-class structures is an important driver of compensation design.

Second, prior literature seldom controls for CEO stock ownership even though it is an important determinant of other compensation choices and varies considerably between dual-class and single-class firms. In theory, executives with greater equity stakes have greater incentives to build economic value, as actions impairing firm value would do damage to the executive’s personal wealth (Larcker and Tayan, 2011). Therefore, this study matches dual-class firms to a control group of single-class firms that are similar in terms of CEO stock ownership.

Finally, the findings suggest that dual-class firms shield their executives from short-term market pressures and design compensation contracts that deemphasize volatile stock prices. The findings favor the optimal contracting view over the managerial power view, and they inform the debate about the purpose of dual-class firms.

The remainder of this paper proceeds as follows. Section 2 develops relevant hypotheses and places this paper in the context of related research. Section 3 describes how the sample data is generated and compares dual-class and non-dual-class firms on certain dimensions of stock awards. Section 4 reports the results of matching analysis, regression analysis and sensitivity analysis, and Section 5 provides concluding remarks on the findings.

2. Literature review and hypothesis development

2.1 Literature review

Multiple prior studies have investigated the effects of dual-class ownership structures on the quality of disclosures, the informativeness of earnings and dividend policy, business investment decisions, and executive compensation. Overall, prior research does not provide consistent evidence that dual-class structures either benefit or harm ordinary shareholders.

One stream of literature asserts that dual-class firms are more prone to pursue private benefits at shareholders’ expense. Francis et al. (2005) compare the informativeness of earnings for firms with dual-class and single-class equity structures, and the findings show that earnings are generally less informative for dual-class firms. Dual-class structures are deemed to reduce the credibility of earnings. Gompers et al. (2010) find that during the period from 1994 to 2002, dual-class firms perform worse than comparable firms for which all shares confer equal voting rights. They also report that dual-class firms’ value is increasing in insiders’ cash-flow rights and decreasing in insider voting rights. Bebchuk et al. (2000) argue that dual-class equity can create agency costs an order of magnitude larger than the costs associated with a controlling shareholder who also has a majority of the cash flow rights in the corporation.

Another stream of literature finds that a dual-class equity structure has economic benefits. Dimitrov and Jain (2006) show that recapitalization of one class of common stocks into restricted voting stocks is a value enhancing initiative for the general shareholders. Claessens et al. (2000) find that the negative association between issuance of dual-class shares and corporate valuation reported in prior studies is not statistically significant, and do not find evidence that the issuance of dual-class shares separating ownership and control is associated with the valuation discount.

Closely related to this work are several studies that examine dual-class stock structure from the standpoint of executive compensation. Masulis et al. (2009) find that divergence between insider voting and cash flow rights increases managerial extraction of private benefits of control. Specifically, they find that when the divergence between cash flow rights and voting rights widens at dual-class companies:

  • CEOs receive higher compensation; and

  • Capital expenditures contribute less to shareholder value. Further, they report that the bigger the divergence, the greater the rent extraction.

Amoako-Adu et al. (2011) show that family members in executive positions in dual-class companies are paid significantly more than executive family members in single-class companies with concentrated control.

Still, from the perspective of executive compensation, some studies confirm the merits and rationality of dual-class structures. Gomez-Mejia and Wiseman (1997), Grabke-Rundell and Gomez-Mejia (2002) and Core and Larcker (2002) test whether executives are given incentive-based compensation to align their interests with those of outside shareholders, which would be consistent with optimal contract theory. They find that executives receive higher compensation in dual-class firms than in single-class firms, and this higher compensation is to prevent dual-class executives from taking advantage of their higher voting leverage.

Dual-class firms are characterized by a significant amount of family control. DeAngelo and DeAngelo (1985) find that significant family involvement in many dual-class firms, and document explicit acquisition premiums were paid for insiders. Nenova (2003) compares the value of a corporate voting right in dual-class firms across 18 countries, and provides evidence that control is more highly valued in countries with inferior protection of minority shareholders. Gompers et al. (2010) find that the most powerful predictor of a dual-class firm is whether a person’s name appears in the firm’s name. Empirical studies of ownership and control have shown that families and other controlling shareholders frequently use mechanisms like dual-class stock to enhance their families’ excess control over ownership (Villalonga and Amit, 2009). The stock exchanges define a controlled company as a company of which more than 50 per cent of the voting power for the election of directors is held by an individual, group or another company (SEC 2009). In a controlled company, more than 50 per cent of the voting power for the election of directors is held by an individual, group or another company, so concentrated family control is an important factor to consider in the company.

In this study, we are studying dual-class companies with a rigorously controlled sample of single-class companies. We have found that dual-class firms are less likely to use market-based metrics relative to single-class firms. In dual-class firms, the board of directors appoints and incentivizes CEO, and they set out the overall strategic direction and design the CEO compensation contract with less emphasis on market-based performance measures. Davila and Penalva’s study examines all companies, and they do not differentiate dual-class or single-class firms. Davila and Penalva (2006) also find that less weight is put on market-based performance measure compared to accounting-based measures. These two empirical studies complement each other and enrich our understanding of the use of performance measures in CEO compensation.

Importantly, many extant studies comparing dual-class and single-class firms lack controls for CEO stock ownership, which is likely a confounding factor affecting their results. Thus, in this study, CEO stock ownership is controlled to conduct a more rigorous test. Details are discussed in Section 3.

2.2 Hypothesis development

The effect of dual-class structure is examined on three design features of CEOs’ performance-vested stock awards: the length of the performance evaluation period, the use of market-based performance measures, and the use of relative performance measures.

First, an important feature of long-term incentive awards is the length of the period over which performance is measured. A short performance period may promote short-term myopic and opportunistic behavior or even encourage managers to manipulate their performance measures (Mizik, 2010; Dallas, 2012). If the goal of dual-class structures is to promote long-term focus, then the use of short-term performance measures are difficult to justify. Conversely, a long performance period that eliminates unwanted short-term market fluctuations and better coincides with long-term strategic business decisions seems congruent with the contracting justification of dual-class structures. Thus, here is H1:

H1.

Compared to single-class firms, dual-class firms evaluate CEO performance over longer periods when awarding performance-vested stock grants.

Second, the board’s choice of performance measures should reflect company strategy and what type of actions are expected from management (Ittner et al., 1997). The informativeness principle indicates that a measure is useful for contracting as long as it is incrementally informative about managerial efforts (Holmström, 1979). Both accounting measures and stock returns measures are reflective of managerial performance and commonly used in CEO performance evaluation. Prior research examines the use of accounting versus stock returns measures for purposes of awarding CEOs’ cash bonuses (Lambert and Larcker, 1987; Baker, 1987; Core et al., 2003). The evidence generally suggests that cash bonus plans put more weight on market measures than on accounting measures when accounting measures are noisier, which is consistent with prediction of contract theory (Banker and Datar, 1989).

If CEOs are evaluated using stock market-based performance measures, then they would be incentivized to pursue short-term market returns rather than to focus on long-term strategic goals. Thus, greater reliance on market-based performance measures among dual-class firms would contradict the purpose of protecting CEOs’ long-term strategic decision-making from market pressures. As a result, it is hypothesized that if dual-class firms have a long-term orientation, then they will be less likely to use market-based measures to benchmark their CEOs’ performance:

H2.

Compared to single-class firms, dual-class firms are less likely to use stock-based measures when awarding performance-vested stock grants.

Finally, relative performance evaluation (RPE) can be incorporated in performance-vested stock awards to benchmark the firm’s stock return performance or accounting performance against a group of peer firms (Holmström, 1982; Albuquerque, 2009; Gong et al., 2011). Use of RPE might filter out exogenous noise (common shocks) that is unrelated to actions undertaken by the firm, thus enhancing the link between performance measurement and the efforts and actions of the CEOs. However, RPE measures may be problematic in dual-class firms.

If a dual-class structure is established to protect managers from short-term market interference with respect to their unique long-term innovative or strategic business decisions, then it could be challenging for the board to identify an appropriate comparison group against which to benchmark managers’ performance. Even if an appropriate peer group could be identified for a dual-class firm, the dual-class firm could wind up implicitly incorporating short-term-oriented measures in its own evaluation process if firms in the peer group use short-term-oriented performance measures for their executives. Hence, H3 is as follows:

H3.

Compared to single-class firms, dual-class firms are less likely to use peer-based targets than single-class firms when awarding performance-vested stock grants.

3. Sample selection, variables and descriptive statistics

3.1 Sample selection for the dual-class and single-class samples

In this study, the dual-class firm sample covers all the USA dual-class firms in the S&P 1500 from 2007 to 2011. To obtain a comprehensive set of dual-class firms, first, a list of possible candidates from Compustat is constructed. From this candidate sample, annual filings made with the Securities and Exchange Commission are examined to confirm that the company actually has a dual-class stock structure. The final dual-class sample consists of 419 firms.

Two steps are performed to match the dual-class sample with a control group of single-class firms. The first step is to do coarsened exact matching (CEM), which ensures that the treatment and control samples have identical characteristics. This procedure maximizes the quality of matching at the cost of a reduced sample size because control firms with identical characteristics as treatment firms are not always available. A necessary step to ensure an exact match is to convert every continuous variable to a set of different intervals, with each interval represented by an indicator variable (Iacus et al., 2012). In the sample, CEM yields 339 control firms with a single-class structure.

The second step is to do propensity score matching (PSM) to find control observations for the remaining 80 dual-class firms (Guo and Fraser, 2010). PSM still assures that the control sample has similar characteristics as the treatment sample. The main benefit of PSM is that it uses all available control variables and does not require continuous variables to be represented by indicator variables. The propensity score is the predicted value from a Logit model of the likelihood of receiving treatment as a function of the control variables. When we construct the Logit model of the likelihood of adopting a dual-class structure, we have included all the variable that are available in the literature, such as firm size, return on equity, intangible assets, firm growth, industry, etc. (Gompers et al., 2010; Lim, 2016). The propensity score can be used as a measure of the similarity between the treatment firm and control firm.

3.2 Variables

In general, CEO compensation arrangements are comprised of multiple components, including base salary, cash bonuses, restricted stock grants and restricted stock option grants. For grants of restricted stock, different vesting schemes are used: performance vesting and time vesting. For a traditional time-vesting stock award, a stock will simply vest upon the completion of a time-based service requirement (e.g. three-year service-based vesting). Time-based vesting does not take performance into account; stock vests with the passage of time. On the other hand, vesting of performance-based stock awards occurs upon attainment of pre-established absolute or relative targets. Vesting requirements use measures of company performance. If CEO does not meet the requirements the company set forth for the performance evaluation period, the stock shares are typically forfeited to the company. Only performance-vesting stock awards explicitly incorporate performance measures for evaluation purposes.

Proxy statement data are hand collected on the choice of performance measures used in CEO stock compensation. Vesting of stock grants to executives is triggered by performance-vesting provisions. The criteria for number of restricted stock units vested are contingent on one or more performance metrics. Therefore, the CEO stock compensation is the performance-vesting award. Performance metrics are classified into the following seven broad categories following Gao et al. (2012):

  • stock returns;

  • earnings and other bottom-line measures such as EPS, EPS growth, operating income, net income and operating margin;

  • accounting return measures such as return on equity (ROE) and return on assets (ROA);

  • sales and sales growth;

  • cash flow;

  • other financial measures, such as market share; and

  • non-financial measures, such as customer satisfaction.

Performance on any of these metrics can be evaluated against absolute targets or relative to the performance of a group of peers.

To test the hypotheses, three main variables are constructed: STOCK is an indicator variable for the use of stock returns as one of the performance measures. PEERS is an indicator variable for RPE on at least one of the performance measures. LENGTH describes how many years of a CEO’s performance is assessed in terms of the designated metrics when awarding stock compensation.

DUAL is an indicator variable measuring if the firm has a dual-class structure. Dual-class firms are characterized by a significant amount of family control. DeAngelo and DeAngelo (1985) find that significant family involvement in many dual-class firms, and document explicit acquisition premiums were paid for insiders. Nenova (2003) compares the value of a corporate voting right in dual-class firms across 18 countries, and provides evidence that control is more highly valued in countries with inferior protection of minority shareholders. Gompers et al. (2010) find that the most powerful predictor of a dual-class firm is whether a person’s name appears in the firm’s name. Empirical studies of ownership and control have shown that families and other controlling shareholders frequently use mechanisms like dual-class stock to enhance their families’ excess control over ownership (Villalonga and Amit, 2009). The stock exchanges define a controlled company as a company of which more than 50 per cent of the voting power for the election of directors is held by an individual, group or another company (SEC 2009). Variable CONTROLLED defines a controlled company as a company of which more than 50 per cent of the voting power for the election of directors is held by an individual, group or another company. It is not surprising to find that nearly 47 per cent of dual-class firms are controlled company relative to 1.44 per cent of single-class firms. This finding is consistent with the inherent property of a dual-class firm, requiring the decision-making control of the firm. This variable reflects concentrated family control in the company.

OWN refers to CEO equity ownership, and measures the percentage of firm equity owned by the CEO. It is calculated as the number of shares owned by the CEO (with options excluded) divided by the number of common shares outstanding at the end of the fiscal year. CEO ownership is an important variable to control for in the matching process because it affects other compensation choices and at the same time is relatively high in dual-class firms.

SIZE is defined as the natural log of total assets. ROE is annual return on equity for the sample company. LEVERAGE is the debt-to-equity ratio. MTB is the market-to-book ratio, calculated as the market capitalization four months after fiscal year end divided by common equity. EBITVOL is earnings volatility, and measured as the standard deviation of annual earnings over prior five years. SALEGROW captures the firm’s annual sales growth rate. For both the CEM and PSM matched samples, controlling is also performed for the 10 Fama–French 48 industries that differentiate the most between dual-class and single-class firms[3]. Moreover, the need for raising extra capital is captured by the variable CAPXS in this paper. CAPXS is equal to capital expenditures scaled by sales. The larger capital expenditure indicates stronger need for raising extra capital. Family firm is captured by an additional dummy explanatory variable FAMILY in the model. Family describes whether the founder or any founder related family member serves in the board of directors, and it is equal to 1 if yes and 0 otherwise. STOCKP is defined as the percentage of CEO stock compensation among the total compensation.

3.3 Descriptive statistics

Table I reports descriptive statistics concerning characteristics of dual- and single-class firms. The matched single-class firms are similar to the dual-class firms at the median value in terms of size, leverage, ROE, market-to-book, and CEO equity ownership percentage, implying that the matching process has generated a control sample effectively. Dual-class firms tend to have lower sales growth, lower market value, less leverage, and lower profitability (ROE) compared to S&P 1500 firms, but are similar in terms of size. However, dual-class firms have higher capital expenditures than S&P 1500 firms.

The percentage of media firm in the sample is also displayed in Table I. We can see that for dual-class firms within S&P 1500, 12.71 per cent of dual-class firms are from media industry. As we do a matching sample of single-class firms for dual-class firms, 12.26 per cent of single-class firms are also from media industry. This finding not only shows that the matching process has generated an appropriate single-class firm sample, but also indicates that the special industry characteristic of media industry has received attention and consideration in the methodology analysis.

Table II shows the adoption of performance-vesting and time-vesting stock awards among dual-class and single-class firms. Performance-based stock awards are relatively more frequently adopted in single-class firms. In addition, time-vesting stock awards are commonly used in both dual-class and single-class firms.

Figures 1 and 2 show that the distribution of CEO stock ownership in dual-class and single-class firms is similar. This is because the sample matching procedures selected single-class firms with the same or closest CEO ownership percentage as in the dual-class firms. In contrast, Figures 3 and 4 suggest the distribution of CEO stock ownership is different in the broader sample of S&P 1500 firm. In particular, CEOs in S&P 1500 firms are much less likely to have equity stakes exceeding 5 per cent of firm stock.

4. Research design and results

4.1 Matching analysis

This section uses matching estimators to provide an analysis of how a dual-class structure affects the design of performance measures in performance-based stock awards. Matching estimators are increasingly used in executive compensation and performance measure research (Armstrong et al., 2010; Casas-Arce et al., 2013). As discussed earlier, the sample of dual-class firms is matched to a control sample of single-class firms in the S&P 1500 firms with similar characteristics. The CEM and PSM designs control for all main characteristics of the firms except the horizon measures under investigation. Thus, using these two matching procedures ensures identical or similar characteristics between the control sample and treatment sample. As influential control variables are all included in the matching process, the in-sample homogeneity enables a direct contrast between dual-class and single-class firms in terms of matching estimators. The results of matching analysis are provided in Table III.

H1 predicts that dual-class firms use a longer performance evaluation period for CEOs’ performance-vesting stock grants. Comparison is conducted for the length of the performance evaluation periods used by dual-class and single-class firms. As Table III Panel A shows, the finding is that, on average, dual-class firms evaluate CEO performance over a 2.35-year span, while single-class firms assess CEO performance over a 2.44-year span when awarding performance-vested stock compensation – a statistically insignificant difference (p-value = 0.757). Therefore, the results of this test do not provide evidence that distinguishes between optimal contracting and managerial entrenchment, which implies that dual-class firms do not use shorter evaluation periods to ease their CEOs’ achievement of performance targets.

H2 predicts that compared to single-class firms, dual-class firms are less likely to use market-based measures when awarding performance-vesting stock grants. Findings are that only 8.8 per cent of dual-class firms use market-based metrics, while 37.1 per cent of single-class firms use them, indicating that market-based metrics are less likely to be used by dual-class firms relative to single-class firms. The difference in the adoption of market-based metrics between single-class and dual-class firms is statistically significant (p < 0.001). This result suggests that, consistent with H2, dual-class firms shield their CEOs from short-term market fluctuations and enable them to pay more attention to long-term strategic development.

Finally, comparison is made for the use of peer-based measures across dual-class and single-class firms. H3 predicts that dual-class firms are less likely to adopt peer-based measures in performance-vested stock awards. Consistent with this hypothesis, the finding is that 6.9 per cent of dual-class firms use peer-based metrics as compared to 26.4 per cent of single-class firms as shown in Table III Panel C. This result is consistent with the board adopting absolute measures to avoid the use of inappropriate peer companies as benchmarks.

4.2 Regression analysis

In this section, an alternative research design is used to test the hypotheses. Matching methodology finds matched firms based on the characteristics of the variables matched. As supposed to PSM and CEM, logistic regression is able to control as many variables of interest as needed.

Specifically, separate regression models of performance measure choice as a function of dual-class structure are estimated using the following framework:

(1) PMCHOICEi=α0+α1DUALi+α2SIZEi+α3LEVERAGEi+α4ROEi+α5MTBi                           +α6EBITVOLi+α7SALEGROWi+α8STOCKAWARDi+α9CONTROLLEDi                           +α10FAMILYi+α11CAPXSi+α12OWNi+α13STOCKPi+εi
where the dependent variable is equal to:
  • The length of the performance period, as measured in years (LENGTH);

  • Whether the firm uses market-based metrics (STOCK); or

  • Whether the firm uses peer-based metrics (PEERS).

As LENGTH is a continuous variable measured in years, the LENGTH model is estimated via ordinary least squares regression. The STOCK and PEERS models are estimated via logistic regression, as these variables are dichotomous.

The independent variables are as follows. DUAL is an indicator variable measuring if the firm has a dual class structure. This study controls for the factors shown in prior literature to be the most influential factors in adopting a dual-class stock structure, including firm size (SIZE), accounting ROE, the debt-to-equity ratio (LEVERAGE) and the market-to-book ratio (MTB). OWN is defined as percentage of total shares owned by the CEO with options excluded. The percentage gap in industry density between dual class and single class firms is very pronounced in ten industries, so these industries are controlled for in the regression. Year fixed effects are also included. STOCKP is defined as the percentage of CEO stock compensation among the total compensation.

There might be an endogeneity issue in terms of OWN and STOCKP variables. As these two variables are potentially predetermined simultaneously with dependent variables, they might be related to the error term. To address this possible endogeneity issue for variables OWN and STOCKP, two additional regressions are estimated for each model that omit OWN or STOCKP. If the regressions show consistent results, then it means endogeneity is not a problem.

H1 predicts that dual-class firms build a longer performance assessment period into their CEOs’ performance-vesting stock grants than single-class firms do. Table IV reports the empirical results of the LENGTH regressions, which test H1. The coefficient of DUAL in the full regression is statistically insignificant, and the additional regressions omitting OWN and STOCKP show results consistent with those of the full regression. Overall, no significant difference is found in performance period length between dual- and non-dual-class firms. Thus, no evidence is found in support of either optimal contracting or managerial power theory, as the length of the performance evaluation period appears to be unrelated to a dual-class structure.

H2 predicts that dual-class firms are less inclined to use market-based performance measures for performance-vesting stock grants. Table V reports the empirical results estimating the effect of a dual-class stock structure on the choice to use stock-market-based performance measures. Consistent with H2, DUAL’s coefficient is negative and significant at the 1 per cent level, and the supplemental regressions omitting OWN and STOCKP yield similar results. These findings indicate that dual-class firms are less likely to evaluate the CEO’s performance based on stock-market targets for purposes of performance-contingent stock compensation. Table V shows that concentrated controlling represented by variable CONTROLLED is not a significant factor in choosing market-based performance measures. Therefore, the choice of market-based performance measures in dual-class firms is associated with the dual-class structure rather than the concentrated control. In addition, significantly negative coefficient of FAMILY variable tells us that family firms are less likely to use market-based performance measures. Family firms with a long horizon legacy building focus do not prefer to use volatile and ever-changing stock market measures to motivate and evaluate CEO performance, consistent with the optimal contracting theory.

Finally, H3 predicts that dual-class firms are less likely to use RPE to evaluate and benchmark CEOs’ performance. Hence, it is anticipated that the effect of the dual-class variable (DUAL) in the PEER regression to be negative. As shown in Table VI, the significantly negative coefficient for DUAL indicates that dual-class firms are more inclined to use absolute performance measures than comparable single-class firms. The variable STOCKAWARD controlled the optimal level of stock compensation in the analysis. Both Tables V and VI have shown that the estimated coefficient of STOCKAWARD is statically insignificant. This result has informed us that the choice of performance measures is significantly associated with a dual-class structure, but not associated with the optimal level of compensation.

Table VI also shows that concentrated controlling represented by variable CONTROLLED is not a significant factor in choosing peer-based performance measures. Therefore, the choice of peer-based performance measures in dual-class firms is associated with the dual-class structure rather than the concentrated control. In addition, significantly negative coefficient of FAMILY variable informs us that family firms are less likely to use peer-based performance measures. Family firms with a long horizon legacy building focus do not prefer to use relative performance measures that may incorporate volatile stock market measures to assess CEO performance, consistent with the optimal contracting theory.

The finding that dual-class firms are less likely to use relative performance measures is consistent with the optimal contracting explanation of H3. In other words, identifying an appropriate set of peers for benchmark purposes maybe difficult for firm that has a unique and innovative business model. Hence, on average, dual-class firms are less likely to use RPE for long-term stock awards. This finding is also consistent with the hypothesis that when a firm adopts dual-class stock structure, the likelihood for using absolute performance measures increases. Dual-class firms are more inclined to protect CEOs’ incentives to innovate, and therefore provide forms of compensation that shield their CEOs’ long-term business decisions from market pressures. In this sense, dual-class firms’ claims of long-term orientation appear justified.

4.3 Sensitivity analysis

To measure a dual-class firm, we have used the indicator variable DUAL in the main analysis. For a dual-class firm, the inferior stock has one vote per share while superior stock has multiple voting rights. Although these two classes of shares represent the same underlying ownership in the company, the superior shares have greater voting rights per share and thus more control. The divergence between the percentage of voting rights and the percentage of cash flow rights controlled by the insiders for dual-class firms can be used to measure a dual-class firm. Therefore, we have constructed a ratio of the percentage of voting rights controlled by the insiders to the percentage of cash flow rights controlled by the insiders for each firm. If this ratio is equal to 1, then the company with this ratio is a single-class firm where the insiders’ voting rights are the same as their cash flow rights. If this ratio is larger than 1, then such companies with this ratio are dual-class firms where the insiders hold more voting rights than their cash flow rights.

Specifically, separate regression models of performance measure choice as a function of dual-class structure are estimated using the following framework:

(2) PMCHOICEi=α0+α1RATIOi+α2SIZEi+α3LEVERAGEi+α4ROEi+α5MTBi                           +α6EBITVOLi+α7SALEGROWi+α8STOCKAWARDi+α9CONTROLLEDi                           +α10FAMILYi+α11CAPXSi+α12OWNi+α13STOCKPi+εi
where the dependent variable is equal to:
  • The length of the performance period, as measured in years (LENGTH);

  • Whether the firm uses market-based metrics (STOCK); or

  • Whether the firm uses peer-based metrics (PEERS).

As shown in Tables VII-IX, the sensitivity analysis results are basically consistent with the analysis results using the indicator variable DUAL to represent a dual-class firm. In all these analyses regarding performance measure choice, the results and conclusions still hold.

5. Conclusion

The rationale for dual-class stock structures continues to be debated in the academic literature. This study investigates whether dual-class firms incentivize their CEOs by granting performance-based stock awards that incorporate long-horizon metrics. This paper is among the first to examine differences in performance measures used by dual-class and single-class firms. Specifically, the measures used for performance-contingent stock compensation are examined for CEOs and find evidence that a dual-class structure is associated with a lower probability of using stock-market-based performance measures and peer-based metrics relative to a single-class structure. Taken together, this evidence is consistent with the notion that CEOs in dual-class firms are shielded from short-term market pressures and provides evidence in support of the optimal contracting theory. This study also finds that the length of the performance evaluation period does not differ between dual-class and single-class firms. This result suggests that dual-class firms do not use shorter evaluation periods to ease their CEOs’ achievement of performance targets.

Analysis results also have informed us that the choice of performance measures is significantly associated with a dual-class structure, but not associated with the optimal level of compensation. In addition, the analysis about family firm tells us that family firms are less likely to use market-based and peer-based performance measures. Family firms with a long horizon legacy building focus do not prefer to use volatile and ever-changing stock market measures to motivate and evaluate CEO performance, consistent with the optimal contracting theory. Importantly, a controlled company reflects concentrated family control in the company. The results also show that concentrated controlling is not a significant factor in choosing market-based and peer-based performance measures. Thus, the choice of market-based and peer-based performance measures in dual-class firms is associated with the dual-class structure rather than the concentrated control.

In this study, the focus is on one component of CEO compensation – performance-contingent stock awards – because it is well suited to examining whether CEOs of dual-class firms are incentivized to be long-term- or short-term-oriented. Besides the stock option awards, multi-year bonus plans could be another channel for examining the performance evaluation horizon of dual-class firms. Furthermore, most performance evaluation periods in this sample are either one year or three years in length. The length of the performance evaluation period may be subject to the influence of compensation consultants who might offer the same suggestions to different companies, resulting in similar performance evaluation periods across dual-class and single-class firms.

Recently, more private companies choose a dual-class stock structure when they go public. According to data analysis provided by Dealogic, there are 98 IPO firms that are listed on USA exchanges and that have chosen a dual-class structure, while the number was 59 between 2010 and 2012. The findings in the design of performance measures can also provide guidance and reference for new IPO companies when they set up executive stock compensation plan.

By examining the performance measures of performance-based stock awards, our results have enriched researchers’ understanding of the selection of performance measures in CEO’s performance-based stock awards. Our findings reveal the relationships between the dual-class stock structure and the contractual features of CEO performance-based stock awards, provide empirical evidence for the company’s compensation committee, and provide implications for the evolving practices of performance measures regarding CEO stock compensation. The findings are also useful to regulators, compensation consultants and firms pursuing efficient design of executive compensation.

Figures

Distribution of CEO stock ownership for dual-class firms

Figure 1.

Distribution of CEO stock ownership for dual-class firms

Distribution of CEO stock ownership for single-class firms

Figure 2.

Distribution of CEO stock ownership for single-class firms

Distribution of CEO stock ownership for S&P 1500 firms

Figure 3.

Distribution of CEO stock ownership for S&P 1500 firms

Another presentation of distribution for dual-class, single-class firms and S&P 1500 firms

Figure 4.

Another presentation of distribution for dual-class, single-class firms and S&P 1500 firms

Descriptive statistics for dual-class firms, single-class firms and S&P 1500 firms

Variable Dual N Mean SD p25 p50 p75
SIZE 1 419 7.857 1.624 6.719 7.541 8.700
0 419 8.014 1.796 6.674 7.814 9.027
1,500 7,500 7.987 1.669 6.763 7.856 9.010
LEVERAGE 1 419 0.168 0.177 0.016 0.126 0.260
0 419 0.183 0.192 0.012 0.153 0.267
1,500 7,500 0.184 0.170 0.027 0.155 0.291
ROE 1 419 −0.015 0.844 0.023 0.086 0.151
0 419 0.030 1.470 0.028 0.096 0.191
1,500 7,500 0.091 2.569 0.047 0.109 0.177
MTB 1 419 1.752 9.815 1.083 1.641 2.825
0 419 2.813 4.942 1.192 1.873 3.112
1,500 7,500 2.555 19.518 1.252 1.892 3.011
SALEGROW 1 419 5.215 18.129 −2.652 4.590 13.002
0 419 9.718 59.859 −4.068 5.235 13.943
1,500 7,500 7.353 28.509 −3.129 5.963 14.889
MV 1 419 9374 26740 642 1574 4836
0 419 10733 29529 733 1955 7598
1,500 7,500 10025 28954 725 1874 7026
MEDIA 1 419 12.706 0.333 0 0 0
0 419 12.260 0.328 0 0 0
1,500 7,500 3.572 0.857 0 0 0
OWN 1 419 5.612 11.206 0.097 0.659 4.785
0 419 4.036 8.786 0.115 0.384 1.974
1,500 7,500 1.790 5.064 0.108 0.323 1.013
CAPXS 1 419 0.045 0.048 0.016 0.032 0.053
0 419 0.052 0.089 0.017 0.029 0.049
1,500 7,500 0.049 0.078 0.014 0.025 0.039

Notes: SIZE is defined as the natural log of total assets. ROE is annual return on equity for the sample company. LEVERAGE is the debt-to-equity ratio. MTB is the market-to-book ratio, calculated as the market capitalization four months after fiscal year end divided by common equity. SALEGROW captures the firm’s annual sales growth rate. MV is market value, calculated as the number of common shares outstanding multiplied by the closing price at fiscal yearend. MEDIA is equal to 1 if the firm comes from the media industry, and 0 otherwise. OWN refers to CEO equity ownership, and measures the percentage of firm equity owned by the CEO. It is calculated as the number of shares owned by the CEO (with options excluded) divided by the number of common shares outstanding at the end of the fiscal year. CAPXS is equal to capital expenditures scaled by sales

CEO Compensation contract comparison for dual-class and single-class firms

Variable Dual N Mean SD p25 p50 p75
PERFORMANCE 1 419 0.384 0.487 0 0 1
0 419 0.539 0.499 0 1 1
TIME-VESTING 1 419 0.403 0.491 0 0 1
0 419 0.482 0.500 0 0 1
SALARY 1 419 935.103 791.801 609.808 870 1,000
0 419 848.452 486.808 550 741.756 1,000
BONUS 1 419 291.455 1,228.438 0 0 0
0 419 446.258 2,560.984 0 0 0
STOCK 1 419 2,114.843 7193.6 0 648.543 1,844.25
0 419 2,141.778 3,239.162 46.552 1,038.96 2,624.573
STOCKP 1 419 0.239 0.293 0 0.195 0.360
0 419 0.329 0.412 0.032 0.270 0.468
DUALITY 1 419 0.505 0.501 0 1 1
0 419 0.611 0.488 0 1 1
INDDIR 1 419 6.345 2.761 5 6 8
0 419 7.271 2.302 6 7 9

Notes: PERFORMANCE describes whether or not the sample firm adopts performance-vesting stock awards for its CEO compensation. Vesting of performance-based stock awards occurs upon attainment of pre-established absolute or relative targets of firm performance. TIME-VESTING describes whether or not the sample firm uses time-vesting stock awards for its CEO compensation. Time-vesting stock awards vest with the passage of time. SALARY is the CEO’s base salary compensation. BONUS is the CEO’s bonus compensation disclosed in the proxy statement. STOCK is the CEO’s stock compensation. STOCKP is defined as the percentage of CEO stock compensation among the total compensation. DUALITY describes the dual role of CEO, and it is equal to 1 if CEO also holds the role of chairman of the board, and 0 otherwise. INDDIR describes board independence, and it is the number of independent directors

Propensity score matching analysis on performance measure choices

ObsMean DifferenceT-statp-value
Panel A: Performance evaluation period length
LENGTH
Treated 161 2.352 −0.088 −0.63 0.757
Controls 159 2.440
Panel B: Stock market-based performance measures
STOCK
Treated 161 0.088 −0.283 −6.35 0.000
Controls 159 0.371
 
Panel C: Peers-based performance measures 
PEERS
Treated 161 0.069 −0.195 −4.82 0.000
Controls 159 0.264

Notes: LENGTH describes how many years of a CEO’s performance is assessed in terms of the designated metrics when awarding stock compensation.; STOCK is an indicator variable for the use of stock returns as one of the performance measures; PEERS is an indicator variable for relative performance evaluation on at least one of the performance measures

Regression analysis on the length of performance evaluation period

Variable Pred. Sign Coef. z p-value Coef. z p-value Coef. z p-value
DUAL + 0.094 2.35 0.199 0.039 2.46 0.148 0.072 2.19 0.206
SIZE + 0.180 5.09 <0.0001 0.179 5.05 <0.0001 0.175 5.06 <0.0001
LEVARAGE −0.086 −0.31 0.754 −0.050 −0.18 0.855 0.015 0.06 0.955
ROE + 0.030 0.68 0.050 0.035 0.79 0.043 0.033 0.79 0.043
MTB −0.002 −0.24 0.814 −0.002 −0.25 0.800 −0.002 −0.24 0.814
EBITVOL + 0.010 0.66 0.508 0.011 0.72 0.472 0.011 0.8 0.426
SALEGROW −0.003 −1.16 0.245 −0.002 −0.97 0.331 −0.002 −1.81 0.070
STOCKAWARD + 0.001 2.1 0.359 0.001 3.07 0.201 0.001 2.51 0.129
CONTROLLED + 0.162 1.21 0.226 0.144 1.07 0.283 0.120 0.92 0.356
FAMILY −0.172 −1.43 0.153 −0.183 −1.52 0.129 −0.185 −1.58 0.114
CAPXS + 0.001 1.54 0.123 0.001 1.6 0.110 0.001 1.62 0.106
OWN −0.003 −0.53 0.597 −0.005 −0.88 0.38
STOCKP + 0.425 2.92 0.004 0.336 2.4 0.017
CONS ? −0.278 −0.96 0.000 −0.153 −0.54 0.000 −0.253 −0.91 0.000
Industry controls Yes Yes Yes
F Value 9.48 9.47 9.96
Prob> F <0.0001 <0.0001 <0.0001
Sample size 387 387 387
Adjusted R2(%) 5.76 4.95 5.35

Notes: The dependent variable, LENGTH, describes how many years of a CEO’s performance is assessed in terms of the designated metrics when awarding stock compensation. DUAL is an indicator variable measuring if the firm has a dual class structure. SIZE is defined as the natural log of total assets. LEVERAGE is the debt-to-equity ratio. ROE is annual return on equity for the sample company. MTB is the market-to-book ratio, calculated as the market capitalization four months after fiscal year end divided by common equity. EBITVOL is earnings volatility, and measured as the standard deviation of annual earnings over prior five years. SALEGROW captures the firm’s annual sales growth rate. CONTROLLED defines a controlled company as a company of which more than 50% of the voting power for the election of director is held by an individual, group or another company. FAMILY describes whether the founder or any founder related family member serves in the board of directors, and it is equal to 1 if yes and 0 otherwise. CAPXS is equal to capital expenditures scaled by sales. OWN refers to CEO equity ownership, and measures the percentage of firm equity owned by the CEO. It is calculated as the number of shares owned by the CEO (with options excluded) divided by the number of common shares outstanding at the end of the fiscal year. STOCKP is defined as the percentage of CEO stock compensation among the total compensation

Logistic model on the use of market-based performance measures

Variable Pred. Sign Coef. z p-value Coef. z p-value Coef. z p-value
DUAL −1.326 11.545 0.001 −1.334 11.713 0.001 −1.245 10.734 0.001
SIZE + 0.276 9.720 0.002 0.262 9.458 0.002 0.309 13.009 0.0003
LEVARAGE + 0.644 0.920 0.338 0.604 0.815 0.367 0.815 1.553 0.213
ROE + 0.554 1.466 0.226 0.501 1.264 0.261 0.544 1.369 0.242
MTB −0.003 0.007 0.932 0.003 0.009 0.924 −0.003 0.008 0.930
EBITVOL + 0.091 9.004 0.003 0.093 9.559 0.002 0.050 2.155 0.142
SALEGROW ? 0.007 1.802 0.180 0.008 2.667 0.103 −0.004 2.770 0.096
STOCKAWARD ? −0.001 0.080 0.777 0.001 0.091 0.763 −0.001 0.019 0.890
CONTROLLED −0.181 0.106 0.745 −0.296 0.290 0.590 −0.225 0.168 0.682
FAMILY −0.812 4.838 0.028 −0.798 4.740 0.030 −1.054 9.392 0.002
CAPXS + 0.001 4.011 0.045 0.002 4.517 0.034 0.001 3.882 0.049
OWN −0.083 3.586 0.058 −0.087 4.150 0.042
STOCKP + 0.688 5.217 0.022 0.705 6.379 0.012
CONS ? −4.137 28.387 0.000 −3.815 26.510 0.000 –4.461 34.736 0.000
Industry controls Yes Yes Yes
Log likelihood 148.723 143.705 136.335
Prob> chi2 < 0.0001 < 0.0001 < 0.0001
Sample size 387 387 387
Pseudo R2(%) 20.58 19.30 19.24

Notes: The dependent variable, STOCK, is an indicator variable for the use of stock returns as one of the performance measures. DUAL is an indicator variable measuring if the firm has a dual class structure. SIZE is defined as the natural log of total assets. ROE is annual return on equity for the sample company. LEVERAGE is the debt-to-equity ratio. MTB is the market-to-book ratio, calculated as the market capitalization four months after fiscal year end divided by common equity. EBITVOL is earnings volatility, and measured as the standard deviation of annual earnings over prior five years. SALEGROW captures the firm’s annual sales growth rate. CONTROLLED defines a controlled company as a company of which more than 50% of the voting power for the election of director is held by an individual, group or another company. FAMILY describes whether the founder or any founder related family member serves in the board of directors, and it is equal to 1 if yes and 0 otherwise. CAPXS is equal to capital expenditures scaled by sales. OWN refers to CEO equity ownership, and measures the percentage of firm equity owned by the CEO. It is calculated as the number of shares owned by the CEO (with options excluded) divided by the number of common shares outstanding at the end of the fiscal year. STOCKP is defined as the percentage of CEO stock compensation among the total compensation

Logistic model on the use of peer-based performance measures

Variable Pred. Sign Coef. z p-value Coef. z p-value Coef. z p-value
DUAL −1.183 6.796 0.009 −1.156 6.554 0.011 −1.154 6.618 0.010
SIZE + 0.347 10.960 0.001 0.328 9.965 0.002 0.329 10.684 0.001
LEVARAGE + 0.599 0.543 0.461 0.603 0.552 0.457 0.726 0.860 0.354
ROE + 0.509 0.810 0.368 0.469 0.716 0.397 0.554 0.938 0.333
MTB + 0.024 0.304 0.582 0.028 0.424 0.515 0.021 0.232 0.630
EBITVOL −0.232 0.856 0.355 −0.216 0.735 0.391 −0.217 0.868 0.352
SALEGROW + 0.005 0.781 0.377 0.006 1.083 0.298 0.005 0.857 0.355
STOCKAWARD + 0.001 1.651 0.199 0.001 3.149 0.176 0.001 1.975 0.160
CONTROLLED + 0.182 0.094 0.759 0.076 0.017 0.897 0.157 0.072 0.789
FAMILY −1.070 5.556 0.018 −1.081 5.672 0.017 −1.240 8.428 0.004
CAPXS −0.001 1.184 0.277 −0.001 1.289 0.256 −0.001 0.900 0.343
OWN −0.029 0.554 0.457 −0.031 0.628 0.428
STOCKP + 0.455 1.499 0.221 0.355 1.000 0.317
CONS ? −5.148 28.285 0.000 −4.895 27.142 0.000 −4.991 29.387 0.000
Industry controls Yes Yes Yes
Log likelihood 103.598 102.245 101.481
Prob > chi2 <0.0001 <0.0001 <0.0001
Sample size 387 387 387
Pseudo R2(%) 21.75 21.26 20.37

Notes: The dependent variable, PEERS, is an indicator variable for relative performance evaluation on at least one of the performance measures. DUAL is an indicator variable measuring if the firm has a dual class structure. SIZE is defined as the natural log of total assets. ROE is annual return on equity for the sample company. LEVERAGE is the debt-to-equity ratio. MTB is the market-to-book ratio, calculated as the market capitalization four months after fiscal year end divided by common equity. EBITVOL is earnings volatility, and measured as the standard deviation of annual earnings over prior five years. SALEGROW captures the firm’s annual sales growth rate. CONTROLLED defines a controlled company as a company of which more than 50% of the voting power for the election of director is held by an individual, group or another company. FAMILY describes whether the founder or any founder related family member serves in the board of directors, and it is equal to 1 if yes and 0 otherwise. CAPXS is equal to capital expenditures scaled by sales. OWN refers to CEO equity ownership, and measures the percentage of firm equity owned by the CEO. It is calculated as the number of shares owned by the CEO (with options excluded) divided by the number of common shares outstanding at the end of the fiscal year. STOCKP is defined as the percentage of CEO stock compensation among the total compensation

Sensitivity analysis on the length of performance evaluation period

Variable Pred. Sign Coef. z p-value Coef. z p-value Coef. z p-value
RATIO + 0.001 0.136 0.894 0.001 0.193 0.848 0.001 0.124 0.9021
SIZE + 0.156 4.214 <0.0001 0.147 3.990 <0.0001 0.157 4.293 <0.0001
LEVARAGE −0.030 −0.115 0.915 0.009 0.037 0.973 −0.024 −0.097 0.929
ROE + 0.027 0.623 0.539 0.029 0.673 0.504 0.027 0.615 0.539
MTB 0.0001 0.016 0.991 −0.0001 0.001 0.999 0.0001 0.019 0.992
EBITVOL + 0.008 0.552 0.584 0.009 0.586 0.562 0.008 0.543 0.586
SALEGROW −0.003 −1.241 0.217 −0.003 −1.149 0.253 −0.003 −1.247 0.215
STOCKAWARD + 0.001 2.590 0.210 0.001 4.025 0.201 0.001 2.590 0.210
CONTROLLED + 0.009 0.074 0.941 −0.013 −0.113 0.915 0.007 0.064 0.956
FAMILY −0.295 −2.726 0.007 −0.304 −2.790 0.005 −0.298 −2.791 0.005
CAPXS + 0.001 1.029 0.307 0.001 0.816 0.418 0.001 1.025 0.310
OWN −0.001 −0.150 0.884 −0.0018 −0.351 0.729
STOCKP + 0.309 1.936 0.054 0.3119 1.962 0.051
CONS ? −0.181 −0.618 0.000 −0.0502 −0.170 0.000 −0.191 −0.668 0.000
Industry controls Yes Yes Yes
F Value 9.15 9.57 9.93
Prob > F <0.0001 <0.0001 <0.0001
Sample size 387 387 387
Adjusted R2(%) 5.52 5.22 5.63

Notes: The dependent variable, LENGTH, describes how many years of a CEO’s performance is assessed in terms of the designated metrics when awarding stock compensation. Variable RATIO describes a ratio of the percentage of voting rights controlled by the insiders to the percentage of cash flow rights controlled by the insiders for each firm. If this ratio is equal to 1, then the company with this ratio is a single-class firm where the insiders’ voting rights are the same as their cash flow rights. If this ratio is larger than 1, then such companies with this ratio are dual-class firms where the insiders hold more voting rights than their cash flow rights. SIZE is defined as the natural log of total assets. LEVERAGE is the debt-to-equity ratio. ROE is annual return on equity for the sample company. MTB is the market-to-book ratio, calculated as the market capitalization four months after fiscal year end divided by common equity. EBITVOL is earnings volatility, and measured as the standard deviation of annual earnings over prior five years. SALEGROW captures the firm’s annual sales growth rate. CONTROLLED defines a controlled company as a company of which more than 50% of the voting power for the election of director is held by an individual, group or another company. FAMILY describes whether the founder or any founder related family member serves in the board of directors, and it is equal to 1 if yes and 0 otherwise. CAPXS is equal to capital expenditures scaled by sales. OWN refers to CEO equity ownership, and measures the percentage of firm equity owned by the CEO. It is calculated as the number of shares owned by the CEO (with options excluded) divided by the number of common shares outstanding at the end of the fiscal year. STOCKP is defined as the percentage of CEO stock compensation among the total compensation

Sensitivity analysis on the use of market-based performance measures

Variable Pred. Sign Coef. z p-value Coef. z p-value Coef. z p-value
RATIO −0.003 −0.275 0.060 −0.003 −0.289 0.051 −0.002 −0.197 0.056
SIZE + 0.212 5.842 0.016 0.1861 4.735 0.030 0.229 6.997 0.008
LEVARAGE + 0.743 1.246 0.264 0.762 1.3219 0.250 0.875 1.758 0.185
ROE + 0.612 1.626 0.202 0.537 1.332 0.248 0.652 1.79 0.181
MTB −0.003 0.007 0.933 0.003 0.008 0.928 −0.007 0.041 0.839
EBITVOL + 0.080 6.617 0.0101 0.081 7.033 0.008 0.064 5.648 0.018
SALEGROW ? 0.008 2.228 0.136 0.009 2.976 0.0845 0.008 2.323 0.128
STOCKAWARD ? 0.0001 0.018 0.893 0.0001 1.216 0.2702 0.0001 0.112 0.738
CONTROLLED −0.823 2.603 0.107 −0.932 3.389 0.166 −0.858 2.796 0.110
FAMILY −1.292 13.942 0.0002 −1.295 14.305 0.0002 −1.503 20.714 <0.0001
CAPXS + 0.002 4.231 0.040 0.001 3.670 0.055 0.001 3.757 0.053
OWN −0.078 3.307 0.069 −0.079 3.564 0.059
STOCKP + 0.629 3.904 0.048 0.665 4.346 0.037
CONS ? −3.793 −24.903 0.000 −3.451 −22.580 0.000 −4.06 −29.442 0.000
Industry controls Yes Yes Yes
Log likelihood 136.522 132.919 131.629
Prob > chi2 < 0.0001 < 0.0001 < 0.0001
Sample size 387 387 387
Pseudo R2(%) 21.91 20.36 19.98

Notes: The dependent variable, STOCK, is an indicator variable for the use of stock returns as one of the performance measures. Variable RATIO describes a ratio of the percentage of voting rights controlled by the insiders to the percentage of cash flow rights controlled by the insiders for each firm. If this ratio is equal to 1, then the company with this ratio is a single-class firm where the insiders’ voting rights are the same as their cash flow rights. If this ratio is larger than 1, then such companies with this ratio are dual-class firms where the insiders hold more voting rights than their cash flow rights. SIZE is defined as the natural log of total assets. LEVERAGE is the debt-to-equity ratio. ROE is annual return on equity for the sample company. MTB is the market-to-book ratio, calculated as the market capitalization four months after fiscal year end divided by common equity. EBITVOL is earnings volatility, and measured as the standard deviation of annual earnings over prior five years. SALEGROW captures the firm’s annual sales growth rate. CONTROLLED defines a controlled company as a company of which more than 50% of the voting power for the election of director is held by an individual, group or another company. FAMILY describes whether the founder or any founder related family member serves in the board of directors, and it is equal to 1 if yes and 0 otherwise. CAPXS is equal to capital expenditures scaled by sales. OWN refers to CEO equity ownership, and measures the percentage of firm equity owned by the CEO. It is calculated as the number of shares owned by the CEO (with options excluded) divided by the number of common shares outstanding at the end of the fiscal year. STOCKP is defined as the percentage of CEO stock compensation among the total compensation

Sensitivity analysis on the use of peer-based performance measures

Variable Pred. Sign Coef. z p-value Coef. z p-value Coef. z p-value
RATIO −0.007 −1.737 0.018 −0.006 −1.655 0.019 −0.006 −1.451 0.028
SIZE + 0.300 8.540 0.004 0.282 7.841 0.005 0.314 9.561 0.002
LEVARAGE + 0.596 0.5461 0.460 0.605 0.565 0.452 0.725 0.833 0.361
ROE + 0.580 0.9396 0.332 0.523 0.797 0.372 0.597 0.977 0.323
MTB + 0.024 0.299 0.585 0.030 0.435 0.510 0.023 0.257 0.612
EBITVOL −0.256 0.932 0.335 −0.245 0.842 0.359 −0.258 0.970 0.325
SALEGROW + 0.005 0.851 0.356 0.006 1.118 0.290 0.005 0.866 0.352
STOCKAWARD + 0.0001 1.241 0.265 0.0001 3.229 0.207 0.0001 1.536 0.215
CONTROLLED + −0.269 0.251 0.617 −0.351 0.437 0.509 −0.303 0.319 0.572
FAMILY _ −1.205 7.355 0.007 −1.224 7.668 0.006 −1.403 11.544 0.0007
CAPXS −0.001 0.620 0.431 −0.001 0.792 0.374 -0.001 0.810 0.368
OWN _ −0.043 1.016 0.314 −0.043 1.073 0.3002
STOCKP + 0.428 1.222 0.269 0.4424 1.300 0.2541
CONS ? −4.842 25.861 0.000 −4.6027 25.054 0.000 −5.044 29.145 0.000
Industry controls Yes Yes Yes
Log likelihood 95.3749 94.2587 94.0349
Prob > chi2 < 0.0001 < 0.0001 < 0.0001
Sample size 387 387 387
Pseudo R2(%) 19.74 20.01 19.43

Notes: The dependent variable, PEERS, is an indicator variable for relative performance evaluation on at least one of the performance measures. Variable RATIO describes a ratio of the percentage of voting rights controlled by the insiders to the percentage of cash flow rights controlled by the insiders for each firm. If this ratio is equal to 1, then the company with this ratio is a single-class firm where the insiders’ voting rights are the same as their cash flow rights. If this ratio is larger than 1, then such companies with this ratio are dual-class firms where the insiders hold more voting rights than their cash flow rights. SIZE is defined as the natural log of total assets. LEVERAGE is the debt-to-equity ratio. ROE is annual return on equity for the sample company. MTB is the market-to-book ratio, calculated as the market capitalization four months after fiscal year end divided by common equity. EBITVOL is earnings volatility, and measured as the standard deviation of annual earnings over prior five years. SALEGROW captures the firm’s annual sales growth rate. CONTROLLED defines a controlled company as a company of which more than 50% of the voting power for the election of director is held by an individual, group or another company. FAMILY describes whether the founder or any founder related family member serves in the board of directors, and it is equal to 1 if yes and 0 otherwise. CAPXS is equal to capital expenditures scaled by sales. OWN refers to CEO equity ownership, and measures the percentage of firm equity owned by the CEO. It is calculated as the number of shares owned by the CEO (with options excluded) divided by the number of common shares outstanding at the end of the fiscal year. STOCKP is defined as the percentage of CEO stock compensation among the total compensation

Notes

1.

Dual-class firms issue two classes of common stock, designated as inferior stock and superior stock, or Class A and Class B shares. The inferior stock has one vote per share while superior stock has multiple voting rights. Although these two classes of shares represent the same underlying ownership in the company, the non-publicly traded superior shares have greater voting rights per share and thus more control.

2.

Since 2006, the SEC has required firms to disclose executive compensation in more details in the newly created section called “Compensation Discussion and Analysis” (CD&A) in their proxy statements. The SEC’s executive compensation disclosure rules require detailed information on how executive compensation is determined.

3.

These industries are Communication, Petroleum and Natural Gas, Food Products, Printing and Publishing, Apparel, Pharmaceutical Products, Consumer Goods, Electrical Equipment, Machinery, and Entertainment. During the CEM matching, I transform Size, Leverage and Own into three indicator variables, respectively, and ROE and MTB into two indicator variables, respectively. Ten industries are also controlled as indicator variables. The number of indicator variables for every continuous variable is determined by maximizing the explanatory power of the Logistic model of treatment.

Appendix 1

Except from Council of Institutional Investors (CII)’s Correspondence

CII follow-up letter to NYSE meeting on dual-class stock, by Ann Yerger, Dec. 10, 2012

“CII’s primary concerns about the multi-class structures centers on the profound governance challenges created by these structures. Simply put: directors may be less empowered to actively oversee management and make course corrections when they can be elected or fired by founders and/or their descendants.” (Ann Yerger)

Except from Yahoo NewsAppendix 2.

Google to split stock to keep power with founders, by Barbara Ortuyay, April 12, 2012.

Google’s founders argue that Google will be more successful if the company concentrates on its long-term vision.

Without change [issuing a new class of stock with no voting power], senior leaders would eventually lose their voting power. CEO Larry Page and fellow co-founder Sergey Brin said that would undermine “our aspiration for Google over the very long term.”

“It’s important to bear in mind that this proposal will only have an effect on governance over the very long term,” Page and Brin wrote their letter to investors.” It’s just that since we know what we want to do, there’s no reason to delay the decision.” (Larry Page and Sergey Brin)

References

Albuquerque, A. (2009), “Peer firms in relative performance evaluation”, Journal of Accounting and Economics, Vol. 48, pp. 69-89.

Amoako-Adu, B., Baulkaran, V. and Smith, B.F. (2011), “Executive compensation in firms with concentrated control: the impact of dual class structure and family management”, Journal of Corporate Finance, December, Vol. 17 No. 5, pp. 1580-1594.

Armstrong, C.S., Jagolinzer, A.D. and Larcker, D.F. (2010), “Chief executive officer equity incentives and accounting irregularities”, Journal of Accounting Research, Vol. 48 No. 2, pp. 225-271.

Baker, G.P. (1987), “Discussion of an analysis of the use of accounting and market measures of performance in executive compensation contracts”, Journal of Accounting Research, September, pp. 14-17.

Banker, R.D. and Datar, S.M. (1989), “Sensitivity, precision, and linear aggregation of signals for performance evaluation”, Journal of Accounting Research, Vol. 27 No. 1, pp. 21-39.

Bebchuk, L.A., Fried, J.M. and Walker, D.I. (2002), “Managerial power and rent extraction in the design of executive compensation”, The University of Chicago Law Review, Vol. 69 No. 3, pp. 751-846.

Bebchuk, L.A., Kraakman, R. and Triantis, G. (2000), “Stock pyramids, cross-ownership and dual class equity: the mechanisms and agency costs of separating control from cash-flow rights”, in Morck, R. (Ed.), Concentrated Corporate Ownership, University of Chicago Press, Chicago, IL, pp. 445-460.

Casas-Arce, P., Indjejikian, R. and Matějka, M. (2013), “Information Asymmetry and the choice of Financial and Nonfinancial performance targets during an economic downturn”, working paper, W. P. Carey School of Business, Arizona State University.

Claessens, S., Djankov, S. and Lang, L. (2000), “The separation of ownership and control in East Asian corporations”, Journal of Financial Economics, Vol. 58 Nos 1/2, pp. 81-112.

Cohen, M.M. (2017), “Letter to shareholders”, Morgan Stanley, 8 May, p. 2.

Core, J.E. and Larcker, D.F. (2002), “Performance consequences of mandatory increases in executive stock ownership”, Journal of Financial Economics, Vol. 64 No. 3, pp. 317-340.

Core, J.E., Guay, W.R. and Larcker, D.F. (2003), “Executive equity compensation and incentives: a survey”, Economic Policy Review, Vol. 9 No. 1.

Dallas, L. (2012), “Short-termism, the financial crisis, and corporate governance”, Journal of Corporation Law, Vol. 37, pp. 264-298.

Davila, T. and Penalva, F. (2006), “Governance Structure and the Weighting of Performance Measures in CEO Compensation”, Working Paper, IESE Business School, University of Navarra, Navarra, No. 601, 12 January.

DeAngelo, H. and DeAngelo, L. (1985), “Managerial ownership of voting right”, Journal of Financial Economics, Vol. 14 No. 1, pp. 33-69.

Dimitrov, V. and Jain, P. (2006), “Recapitalization of one class of common stock into dual class: growth and long-run stock returns”, Journal of Corporate Finance, Vol. 12 No. 2, pp. 342-366.

Evans, J.H. III., Gao, H., Hwang, Y. and Wu, W. (2018), “Performance periods in CEO performance-based equity awards: theory and evidence”, The Accounting Review, Vol. 93 No. 2, pp. 161-190.

Francis, J., Schipper, K. and Vincent, L. (2005), “Earnings and dividend informativeness when cash flow rights are separated from voting rights”, Journal of Accounting and Economics, Vol. 39 No. 2, pp. 329-360.

Gao, Z., Wu, W. and Hwang, Y. (2012), Contractual Features of Performance-Vested Executive Equity Compensation, Working paper, W. P. Carey School of Business., Arizona State University.

Gomez-Mejia, L. and Wiseman, R. (1997), “Reframing executive compensation: an assessment and outlook”, Journal of Management, Vol. 23 No. 3, pp. 291-374.

Gompers, P.A., Ishii, J. and Metrick, A. (2010), “Extreme governance: an analysis of dual-class firms in the United States”, The ”, Review of Financial Studies, Vol. 23 No. 3, pp. 1051-1088.

Gong, G., Li, L.Y. and Shin, J.Y. (2011), “Relative performance evaluation and related peer groups in executive compensation contracts”, The Accounting Review, Vol. 86 No. 3, pp. 1007-1043.

Guo, S. and Fraser, M.W. (2010), Propensity Score Analysis, SAGE Publications Inc., Thousand Oaks, CA.

Grabke-Rundell, A. and Gomez-Mejia, L.R. (2002), “Power as a determinant of executive compensation”, Human Resource Management Review, Vol. 12 No. 1, pp. 3-21.

Holmström, B. (1979), “Moral hazard and observability”, Bell Journal of Economics, Vol. 10 No. 1, pp. 74-91.

Holmström, B. (1982), “Moral hazard in teams”, Bell Journal of Economics, Vol. 13, pp. 324-340.

Iacus, S.M., King, G. and Porro, G. (2012), “Causal inference without balance checking: coarsened exact matching”, Political Analysis, Vol. 20 No. 1, pp. 1-24.

Ittner, C., Larcker, D.F. and Rajan, M.V. (1997), “The choice of performance measures in annual bonus contracts”, The Accounting Review, April, Vol. 72 No. 2, pp. 231-255.

Johnson, C.H. (1999), “Stock compensation: the most expensive way to pay future cash”, SMU Las Review, Vol. 52, pp. 423-454.

Lambert, R.A. and Larcker, D.F. (1987), “An analysis of the use of accounting and market measures of performance in executive compensation contracts”, Journal of Accounting Research, Vol. 25, pp. 85-125.

Larcker, D.F. and Tayan, B. (2011), Corporate Governance Matters: A Closer Look at Organizational Choices and Their Consequences, Pearson Education, Inc., Upper Saddle River, NJ.

Lim, L. (2016), “Dual-class versus single-class firms: information asymmetry”, Review of Quantitative Finance and Accounting, Vol. 46 No. 4, pp. 763-791.

Masulis, R.W., Wang, C. and Xie, F. (2009), “Agency problems at dual-class companies”, The Journal of Finance, Vol. 64 No. 4, pp. 1697-1727.

Mizik, N. (2010), “The theory and practice of myopic management”, Journal of Marketing Research, Vol. 47 No. 4, pp. 594-611.

Nenova, T. (2003), “The valu4e of corporate voting rights and control: a cross-country analysis”, Journal of Financial Economics, Vol. 68 No. 3, pp. 325-352.

Villalonga, B. and Amit, R. (2009), “How are U.S: family firms controlled?”, Review of Financial Studies, Vol. 22 No. 8, pp. 3047-3091.

Further reading

Janakiraman, S., Lambert, R. and Larcker, D. (1992), “An empirical investigation of the relative performance evaluation hypothesis”, Journal of Accounting Research, Vol. 30, pp. 53-69.

Corresponding author

Ji Li can be contacted at: jli7@csub.edu