Question

What are the ways in which shareholders can achieve control rights that exceed cash flow rights? Corporate Governance

Answer 1

Control right is the right to make decisions that affect the firm's activities after the firm has started.So control right is the right to vote and hence to control.On the other hand, Cash flow rights is the right to receive dividends of the ultimate owner.

When there is a seperation of management and control, managers have control rights with insignificant cash flow rights, whereas shareholders have cash flow rights but no control rights. But there are ways in which shareholders can achieve control rights that exceed cash flow rights, which are explained as under:-

1. A reform in corporate governance to strengthen shareholder rights and protect shareholders from expropriation by corporate insiders.

2. Shareholders should also be provided with shares having superior voting rights along with dominant investors so that they also may achieve control rights.

3. Stock option can also provide a way out to shareholders for achieving control rights that will exceed cash flow rights as it can be useful for aligning the interest of managers with that of shareholders and reduce the wedge between managerial control rights and cash flow rights.

4. Having some debt can impose disciplining effect on the managers and thereby avoiding their practice of keeping free cash flows to undertake unprofitable projects at the expense of shreholders to benefit themselves.

5. If the firms are more inclined to build up large cash reserves,the control rights of the ultimate shareholders exceed its cash flow ownership.

6. Non traded double voting shares and traded non voting shares such as preferred shares and investment certificates allows large shareholders to have control rights far in excess of their cash flow interests.

7. The accumulation of cash by retaining large amount of cash flow i.e. cash flow sensitivity of cash, is viewed as a channel through dominant shareholders with excess control rights can obtain private benefits.

8. The presence of multiple controlling shareholders by splitting the sample according to whether control contestability is high or low.

9. When only one shareholder maintains a lock on control through great seperation of control and cash flow rights.

10. When the agency costs are embedded in liquid assets consistently, it results in achieving control rights that exceed cash flow rights.