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Earnings announcements, trading volume, and price discovery: evidence from dual class firms

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Abstract

This paper investigates price discovery between control shares (the superior voting class) and public shares (the inferior voting class) issued by 62 dual-class firms around 148 quarterly earnings announcements from January 2002 to June 2008. We document substantial informed trading in both control and public shares. The average price discovery of control shares is 46.6 % for positive events and 40.5 % for negative events during the event periods. In addition, before the earnings announcements, abnormal trading volume and price discovery increase significantly in control shares relative to public shares. We find price discovery of control shares increases with relative volume of control shares to public shares and relative bid-ask spread but decreases with relative institutional ownership and relative volatility. Our results suggest that publicly traded superior voting class contributes to price discovery substantially, especially before earnings announcements when the information asymmetry is high. The listing of control shares not only enhances price efficiency, but also provides opportunities for outside sophisticated investors to get voting rights and engage in monitoring. Our study sheds new light on the issues of price discovery and corporate governance of dual-class firms.

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Notes

  1. Heaney et al. (1999) document interesting share return seasonalities and price linkages of Chinese A and B shares of the same companies.

  2. Bamber et al. (2011) provide a survey on trading volume around earnings announcements.

  3. Due to its unique features, Berkshire Hathaway (BRK) is reported separately in Panel B of Table 2, and is discussed in the “Appendix”.

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Acknowledgments

We thank the Editor, Cheng-Few Lee, and two anonymous referees for helpful comments and suggestions. We also thank Edward Dyl for his valuable inputs in the paper. The usual disclaimer applies.

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  1. College of Business, University of Michigan-Dearborn, 19000 Hubbard Dr., Dearborn, MI, 48126, USA

    Qin Wang

  2. College of Business Administration, University of Wisconsin-La Crosse, La Crosse, WI, 54601, USA

    Hsiao-Fen Yang

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Correspondence to Qin Wang.

Appendix: Characteristics of Berkshire Hathaway

Appendix: Characteristics of Berkshire Hathaway

The summary statistics of Berkshire Hathaway is shown in Panel B of Table 2. BRK is different from other dual class firms in many ways due to its unique background of creating its Class B shares. Most dual class ownership arrangements occur when firms raise money from outside investors in their IPOs. On the contrary, BRK’s dual class ownership was developed about 20 years after its IPO in 1976. The average stock price of BRK increased from $67 in 1976 to over $33,000 per share in 1995, with an annual return of a stunning 38.6 %. Although a large number of individual investors would have liked to invest in BRK to benefit from Mr. Buffet’s investment prowess, they were deterred by BRK’s high stock price until an investment firm announced its intention to create a trust whose portfolio would consist entirely of BRK shares. The investment trust allowed individual investors to buy its shares for as little as $1,000. Warren Buffet and BRK’s board of directors adamantly opposed the creation of the Berkshire-only investment trusts. Having BRK go a secondary equity offering (SEO) of Class B stock with a much lower share price was Warren Buffet’s way of preempting the market for these investment trust shares.

The above unique background leads to a very special design of the Berkshire’s ownership structure. First, the cash flow right of a Class B share is 1/30th of that of a Class A share. However, the voting rights of a Class B share is just 1/200th of the voting rights of a Class A share. Second, although each share of a Class A common stock is convertible into 30 shares of Class B common stock, the conversion privilege does not extend in the opposite direction. Third, unlike other dual class firms, most of BRK’s market capitalization continued to be represented by the control shares, not by the public shares because the amount of money the company raised in the SEO was nominal, compared to the company’s overall market capitalization at the time of the issuance. Due to the above special designs, although the average number of shares outstanding is 1, 24 million shares for control shares and 8.99 million shares for public shares, control shares still have higher cash-flow rights and voting rights than public shares. The average market capitalization and stock price are $114 billion and $91, 772 for control shares, compared to about $30 billion and $3,054 for public shares, respectively.

Although its ownership structure is very different, Berkshire still shares some common characteristics of a dual-class firm. Its public shares are preferred by institutional investors and is considerably more liquid than its control shares. Compared to the control shares, the public shares have a lower bid-ask spread, higher trading volume (3.83 vs. 0.104 million shares), higher annual turnover (0.41 vs. 0.08), more trades per year (97 vs. 17 thousands of trade), larger trade size in shares (39 vs. 8 shares), and higher institutional ownership (46 vs. 20 %). Due to the commonality of the trading patterns between Berkshire and other dual-class firms, we include Berkshire in our sample and conduct the empirical tests together.

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Wang, Q., Yang, HF. Earnings announcements, trading volume, and price discovery: evidence from dual class firms. Rev Quant Finan Acc 44, 669–700 (2015). https://doi.org/10.1007/s11156-013-0422-4

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