Controlling Shareholders and Sustainable Corporate Governance: The Role of Dual-Class Shares

Controlling Shareholders and Sustainable Corporate Governance: The Role of Dual-Class Shares

Alessio Pacces

Series number :

Serial Number: 
700/2023

Date posted :

April 07 2023

Last revised :

October 17 2023
SSRN Share

Keywords

  • Corporate Social Responsibility • 
  • innovation • 
  • climate change • 
  • Paris Agreement • 
  • institutional investors • 
  • Entrepreneurship • 
  • private benefits of control • 
  • dual-class shares • 
  • wedge • 
  • Commitment • 
  • sunsets

Low-carbon innovation is necessary to overcome the delay of governments in implementing the Paris agreement. However, large institutional investors only engage in climate risk management. They cannot commit to low-carbon innovation because that is fundamentally uncertain, short-term unprofitable, and their index-tracking strategy is incompatible with screening firm-specific breakthroughs.

To pursue sustainable corporate governance, institutional investors should rather tie their hands with controlling shareholders. Controlling shareholders can contribute their entrepreneurial vision to low-carbon innovation while institutional investors allow them to scale this vision.

This article argues that institutional investors catering to the preferences of climate-conscious beneficiaries should finance controlling shareholders through conditional dual-class shares. Dual-class shares allow relaxing the financial conditions for control. To fulfil their mandate from climate-conscious beneficiaries, institutional investors can outcompete short-term profit-seeking investors offering controlling shareholders a higher wedge between voting rights and economic interest and the possibility to cash in higher idiosyncratic private benefits of control, if successful, conditional on discovering a low-carbon technology.

Having at stake welfare-increasing private benefits of control, as well as all or most of their wealth, controlling shareholders are incentivized to discover low-carbon breakthroughs or to acknowledge failure to do so. Corporate law should facilitate contracting between controlling shareholders and institutional investors to support this incentive. Target-contingent transfer sunsets should allow cashing in control premiums only if the low-carbon innovation succeeds. Divestment sunsets and other contractual safeguards should prevent controlling shareholders from increasing agency cost, without undermining equity capital raising. Dual-class recapitalizations should be allowed with a Majority-of-Minority vote.

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Authors

Professor
Real name:
Alessio Pacces
Research Member
Amsterdam Law School and Business School, University of Amsterdam