Bolstering Family Control: Evidence from Loyalty Shares

In recent years, managers, regulators, and politicians, have often complained about the alleged short-term pressure exercised by the stock market on listed companies. Loyalty shares are probably the most common among the instruments to promote and stimulate long-term investments by shareholders. Indeed, countries like France, Italy, Belgium, and the Netherlands have promulgated laws that either introduced or modified the regulation of loyalty shares.

This emphasis on loyalty shares appears to some extent counterintuitive. In fact, loyalty shares create deviations from the beloved one-share one-vote principle that corporate governance activists and institutional investors have heavily promoted since the early 1990s. The one-share one-vote principle is now a stepstone of many corporate governance codes around the world and deviations from it have been found to favor tunneling (Johnson et al, 2000), reduce market discipline in takeover contests (Grossman and Hart, 1988; Harris and Raviv, 1988), and be in general detrimental to shareholder value (Bebchuk et al, 2000; Adams and Ferreira, 2008).

While proponents of loyalty shares stress their bright side, ie the supposed ability to mitigate short-termism (Bolton and Samama, 2013), a dark side exists as well. Controlling shareholders can use loyalty shares to further insulate themselves from market pressures and weaken minority investors. This could create a trade-off: the benefits of incentivizing long-term investment could be outweighed by the costs originating from the increased separation between ownership and control.

Our work focuses on this crucial point: the exploitation of loyalty shares by controlling shareholders. This question is particularly relevant because of the long-term horizon of controlling shareholders. Families provide firms with patient capital (Bertrand and Schoar, 2006). In this type of situation, the availability of loyalty shares may generate an unintended consequence. By helping controlling shareholders to strengthen their grip on the firm, loyalty shares can bolster the extraction of private benefits to the detriment of minority investors. We study loyalty shares in Italy, a country characterized by firms with concentrated ownership and where family control is widespread (Faccio and Lang, 2002; Barontini and Caprio, 2006).

The introduction of loyalty shares in 2014 represents a complete novelty for Italian firms and their shareholders. The new law allows Italian companies, for the first time, to turn voting shares into loyalty shares through an extraordinary general meeting resolution, rewarding ‘loyal’ shareholders with an additional vote per share. Forty-five Italian listed firms (approximately, one-fifth of all firms listed on the main segment of Borsa Italiana) introduced this new device between 2015 and 2018. The peak of adoptions was reached in 2015, with 18 cases. After that, the number of new adoptions stabilized at around 9 per year.

By comparing the sample of Italian listed firms adopting loyalty shares to the universe of Italian listed firms, we document that family firms are eager to adopt the new voting system. The magnitude of this preference is economically relevant, as family-controlled companies are twice to four-times more likely to adopt loyalty shares than their non-family-controlled counterparts. Even though the introduction of an additional control-enhancement mechanism (CEM) should not be that valuable to them, because they often already have majority control, these families exploit the new tool to strengthen their control over the firm. In a few instances, majority shareholders use loyalty shares to decrease their equity stakes without affecting their control of voting rights. Since the largest shareholder is typically a family and usually under-diversified, this decrease, costless in terms of voting power, allows them to reduce idiosyncratic risk. The evidence presented in the paper also shows that family firms do not adopt loyalty shares in anticipation of an expected equity-diluting transaction, such as a merger or an equity issue. Overall, we interpret these findings as evidence that families exploit loyalty shares to reduce their exposure to firm-specific investment while preserving control, but not to foster external growth.

The second important point made in the paper concerns institutional investors. Enhanced voting rights may be less valuable to institutional investors when a controlling shareholder already exists, and this may reduce the effectiveness of loyalty shares as a solution to short-termism. Consistent with this view, institutional investors in Italian listed companies have opposed loyalty shares and voted against their introduction at the shareholder meetings but have not voted with their feet. The authors, in fact, do not observe a negative market reaction, either at the announcement or at the adoption, and find no evidence of a decrease in institutional investors’ stakes in adopting firms. This behavior appears well-motivated: firms that adopt loyalty shares tend to be more profitable than non-adopters.

The Italian evidence we present extends and complements previous work on loyalty shares that mostly focuses on France (Belot et al, 2018; Bourveau et al, 2018; Becht et al, 2018), where companies have been using loyalty shares since 1966, and the Loi Florange of 2014 made them the default choice for listed companies. While there are some common traits, such as family firms being the most likely adopters of loyalty shares, there are also important differences. In fact, unlike in France, there is no evidence of a wealth effect at the adoption of loyalty shares in Italy. The contrasting results documented for these two countries, characterized by  (La Porta et al, 1998), as well as  (Faccio and Lang, 2002), but differences in terms of loyalty shares regulation, suggest that investors adapt their behavior to the environment they face.

Emanuele Bajo is Professor of Finance at the University of Bologna, Department of Economics.

Massimiliano Barbi is Associate Professor of Finance at the University of Bologna, Department of Management.

Marco Bigelli is Professor of Finance at the University of Bologna, Department of Management.

Ettore Croci is Professor of Finance at the Catholic University of the Sacred Heart of Milan, Department of Economics and Business Management Sciences.