Entrenchment and Investment

When?

Monday 15 October 2012, 13.00

Where?

TBC

Open to:

Public, Staff, Students

Speaker:

Dr Suman Banerjee

Admission information:

Please RSVP to fbelevents@surrey.ac.uk

Refreshments:

Refreshments and a sandwich lunch will be available from 13.00

Biography 

Suman Banerjee is an assistant professor of finance at the Nanyang Business School at Nanyang Technological University in Singapore. Before joining NBS in December 2007, Dr. Banerjee was an assistant professor of finance at the A. B. Freeman School of Business at Tulane University in New Orleans, USA. He received his Masters in Economics and PhD in Finance from the University of Iowa and currently researches on both theory and empirics of corporate control, mergers and acquisitions, product market - financial market inter-linkages and energy finance. He has published in the top academic journals including Journal of Financial Economics, Journal of Finance and Quantitative Analysis, Journal of Business. He is also the recipient of the Caeserea Award for the best paper in risk management from the prestigious Western Finance Association in 2002.  He has obtained several other merit-based awards in the course of his academic career.

He is currently working with Professor Tom Noe of Said Business School in Oxford and hence will be visiting the University of Oxford in the autumn. This gives us the perfect opportunity to invite him over to Surrey. He will be presenting a paper on Entrenchment and Investment (coauthored with Ronald Masulis of University of New South Wales at Sydney).

Abstract

This paper shows that restrictions on the issuance of non-voting shares may cause managers who own equity in the firm to under-invest. When a firm issues voting shares, there is a dilution in the incumbent manager's control rights. This increases the risk to the manager's control of the firm, decreasing his chances of extracting private benefits of control. Thus, the manager may find it optimal to forgo positive NPV investments in an effort to maximize his expected wealth. Non-voting shares allow a firm to raise funds without any dilution in the manager's control rights; hence, it helps to alleviate the under-investment problem. There are costs to the issuance of non-voting shares: Non-voting shares facilitate entrenchment and thereby adversely affect value-enhancing future takeover activities. Also, use of non-voting shares dilutes dividends, because relative to voting shares firms need to issue a larger number of non-voting shares to raise the same level of funds. We obtain conditions under which the benefit of using non-voting shares - higher firm value due to higher investment - outweighs its entrenchment and dilution costs. Others have shown that deviations from “one share-one vote" can be optimal, but our paper is the first to integrate the dual-class decision into the rich body of research on capital structure and under-investment. Our theory is consistent with the empirical findings of Faccio and Masulis (2005) who find fear of loss of control makes managers reluctant to issue voting shares to finance M&A activities. In addition, our model produces a number of new empirical predictions.