Impact and Effectiveness of Ownership Concentration
Corporate concentration is one of most common approach to solve agency problem which is derived from separation of ownership and control. Corporate concentration means that corporate control rights are concentrated in the hands of a small percent of investors with a relatively significant cash flow. (Vishny, 1997) These large investors can hold 10, 20 or higher percent company shares, which simultaneously are large shareholders with enough voting right to put pressure on management decision or with enough opportunity to consume corporate benefits to the exclusion of smaller shareholders (Holderness, 2003).
Corporate concentration was first drawn forth by Berle and Means (1932). In The Modern Corporation and Private Property, he reported that technical advances had increased the scale of many firms because of industrial revolution early in the nineteenth century, therefore enterprises faced the dilemma cannot afford the entire company and “the dissolution of the old atom of ownership into its component parts, control and beneficial ownership”. Accordingly, ownership was separated into large investors and small investors, which set the foundation for modern diffuse ownership corporation intimately associated with the general problem of agency (Jensen, 1976) .
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It was after that concentrated shareholdings seems to be the rule around the world and researchers began to discover that large shareholders with significant stock ownership who generally are owners of the company or top managers.
Background And Impact
Holderness (2003) provides us some possible explanations.” Large-block ownership can be motivated by two factors: the shared benefits of control and the private benefits of control.”
The Shared Benefits
Blockholders have enough opportunity and motivator to control or indirectly impact the asset which can turn into the plan generating futurn benefits, such as cash flows. But these asset or cash flows are owned by all the shareholders, not only the blockholders. In this case, the large-percentage shareholders are driven by superior profits through company management which are theoretically supposed to be shared with outsider investors (Shleifer and Vishny, 1986).
The Private Benefits
large shareholders have the strong inclination to consume corporate profits or resources to the exclusion of outsider investors. It can be best exemplified by the simple case of extra bonus that minority shareholders do not have the access to gain. Barclay and Holderness (1989) were the first to prove systematic evidence of existence of private benefits.
Besides the two factors some scholars argues that ownership concentration is developed owing to low investor protection.
La Portaetal. (1998) to argue that “with poor investor protection, ownership concentration becomes a substitute for legal protection, because only large shareholders can hope to receive are turn on their investment.”
Similarly Denis and McConnell illustrates that “Legal shareholder protection and outside ownership concentration are substitutes” (Denis and McConnell, 2003, Page 21).
Costs And Benefits
Compared with ownership decentralization, ownership centralization is a mechanism can constrain company moral hazard. According to Hart (1980), the large investors will have an incentive to regulate well the company by receiving more than just the share of profits. Besides they can improve firm monitoring through drafting a constitution that is beneficial for company management. Furthermore, large shareholders can gain from the reduction of free-rider problem, especially in takeovers, or extrusion of outsiders to gain the premium. (Shleifer and Vishny 1986)
However, Mike Burkart (1997) later challenges the benefits of blockholder ownership. He argues that constrains on managers through regulaiton may be “expensive”. “A concentrated ownership structure induces high levles of monitoring and control but renders management less active” that is to day, directors and managers tend to be less management initiative if firms are under tight control by shareholders. Meanwhile, blockholders are immune from risk diversification of portfolios (Demsetz and Lehn 1985) or solely focus on their own interests at the cost of other small investors（Holmstrom and Tirole 1993）. Most importantly, takeover opportunities might be lessen by aggressive counterbidding (Burkart 1995)
In all, blockholder ownership comes with both benefits and costs just like its counterpart, ownership decentration. It is an instrument to solve the trade off between control and structure (Mike Burkart,1997). It is better to choose specific ownership structure or how concentrated the ownership is with reference to exact countries, economic environment, and policies ect.
Effectiveness Of Ownership
The relationship between large-percent shareholders and firm value has long been controversially discussed. And Tobin's Q is typically used by researchers as a way to measure firm value. There are several relationships that are consistent with the following empirical findings.
Some scholars (Berle and Means ,1932 and Jensen and Meckling 1976) are supportive that the percentage of block-holder ownership has positive impact on firm value. The share benefits of control are theoretical support behind. Because they believe the harder the director work, the more profits the company would generate.
Jain and Kini（1994）state that firms in the United States tend to have a positive relation between ownership concentration and long-term market return.
It is important to note that while the literature focuses on the United States, studies carried out elsewhere have come to much the same conclusion. Besides Mitton (2002) examines 398 firms across six different countries and observes that stock prices were positively correlated with the percentage of large shareholders concentration in six Asian countries or region during the 1997 financial crisis. Except for this, some other empirical evidence shows similar results based on the study of other countries, for instance, in Australian (Guglar 2001), and in Belgium (Goergen and Renneboog 2001).
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There is also possibility that firm value is negative correlatively with how concentrated the extent of ownership, which can be best exemplified by the study of Europe made by S.Thomsen et.al. The result they attributes to the private benefits of control (Fama and Jensen,1983) which is introduced before.
Steen Thomsena,Torben Pedersena,Hans Kurt Kvist (2005) use Granger tests(Granger,1969) to test the relation in European Union and observe the negative correlation between the two. And further examination would reveal that the more concentrated degree of blockholder ownership, the more obviously the relation expression, especially this association is more than ten percent.
Similarily, Eric R. Gegajlovic et.al (1998) examine the ownership concentration and firm performance relationship over five countries and report one interesting thing that even though firms in the United States and the United Kingdom are more concentrated and stable refering to ownership. There is surprisingly a negative relation between blockhold ownership and firm value in the United States and United Kingdom.
Clifford G. Holderness (2003) addresses the reason that it is not the result in management success causes the high firm value, but the individuals blocks in high-value corporations who can provide increased private profits through internal control.
No Significant Relation
Although many scholars cast light on the relation between ownership concentration and firm value, yet the arguments put forward by advocates of such ideas are increasingly being questioned by plenty of empirical evidence. We now look at this developing controversy.
The relation effect was firstly questioned by Demsetz in 1983. Then Denisand McConnell (2003) emphasizes the system effects is one of determinations in the issue which in the line with empirical study of Steen Thomsena,Torben Pedersena,Hans Kurt (2006). This latter study reports that there is no impact of ownership concentration on firm value.
Moreover recent empirical research propel the idea.
“It is documented that high blockholder ownership is associated with lower subsequent firm value and accounting profitability in the civil law,control-based Governance systems of Continental Europe, but not in the market-based common.” (Steen Thomsena,Torben Pedersena, 2005)
Simultaneously, Hans Kurt Kvist(2005) use Granger tests(Granger,1969) to test the relation in the US and the result is also that no significant association between blockholder ownership and firm value.
Based on all the theatrical and empirical evidence, there comes a paradox that. We find the issue whether block-holder ownership can impact firm value is highly controversial. The reasons behind are full of complexity and uncertain, which indirectly back the notion that ownership concentration in different degree or based on various environment do generate diverse outputs. Besides, such finding also proves the rationality for the existence of contemporary different ownership and control, for instance, keiretsu in Japan and Daimler-Benz AG in German.
In this case, what are the factors could affect the relation between ownership concentration and firm value? Demsetz and Lehn (1985) provide us an answer that it could differ across firms. Furthermore ownership structures could play a key role in the process (Denis and McConnell, 2003).
This area was recently raised by the empirical study of Amir Rubin in 2007. In the research, Amir Rubin divides the association into two hypotheses: one is the adverse selection hypothesis, and the other is the trading hypothesis and then conducts a study based on these two hypotheses. “Liquidity tends to increase with institutional ownership levels; on the other hand, liquidity tends to decrease with institutional concentration.” (Amir Rubin, 2007, page 245)
First, adverse selection hypothesis is occurred owing to information asymmetry. When block-holders have more inside information than minority investors, therefore only small percent of investors would trade after new information enters the market which reduces liquidity (Chiang and Venkatesh, 1988; Kini and Mian, 1995; Heﬂin and Shaw, 2000; Barabanov and McNamara, 2002).
Second, another hypothesis (the trading hypothesis) focuses on transaction costs. This is reasonable because Amir Rubin (2007) believes trading more in the stock market can greatly reduce transaction cost, which in turn increases liquidity.
Executive compensation is always a key issue in corporate governance. It is also the main issue in agency problem. Therefore one question that needs to be asked, is whether block shareholders would pay themselves more than minority investors.
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In reviewing the literature, not many data was found directly showing the answer to questions above. The most important finding was that top company officers do get higher salaries compared with diffuse investors, even if those diffuse investors own similar percent of shares. However, the main weakness of the study is the failure to figure out whether the extra compensation is exactly the motivator of making decision in company investment. Compared with investment fund (“an average of $66 million”) to maintain the control rights of company, excess payment (only between $23,000 and $34,000) is very little. (Holderness, 2003, Page 56; Holderness and Sheehan, 1988)
Prior studies that have noted the impact of ownership concentration on firm takeover activity was firstly found by Stulz (1988). He presents that the frequency of takeover event is negatively related to the degree of ownership concentration. More specifically, the frequency of a merger and acquisition event could fortify managerial stock ownership and vice versa. Later the relation is supported by the study of Morck, Shleifer, and Vishny (1988b) and Walkling and Long (1984). These two investigates a different sample at difference time but both studies contribute to the negative association.
However, the findings of the later study do not support the previous research. Mikkelson and Partch (1989) conduct an investigation in U.S. industrial. And their test contrary reports the result of no significant relationship between the event frequencies and managerial ownership. ”the likelihood that a firm will undergo a change in control vary only between 0.16 and 0.17 across a range of managers' voting control from less than 10% to more than 50% of outstanding votes” (Mikkelson and Partch, 1989, Page 264).They offer one possible explanation: low ownership concentration would lead to higher offer in takeover negotiation, which in turn burdens the possibility of takeover.
Recommendations For Further Research
Recent literatures have realized that the ownership concentration influence the corporate performance differently. It is recommended that further research be undertaken in the following areas:
Firstly, future research demands further cross-national or global studies of ownership concentration. Eric R. Gedajlovic and Daniel M. Shapiro (1998) investigate management and ownership effects among five countries (U.S., U.K., Canada, France, and Germany). As most current studies in this field of finance, they in general only pay attention to the western developed countries. Therefore, further investigations of specification are recommended to global economies, especially those highly growing markets.
Secondly, Eric R. Gedajlovic and Daniel M. Shapiro (1998) also stress the importance on that “Further cross-national research exploring the impact of the institutional environment on the many factors that shape managerial discretion appears to be in order.” (Page 551)
Thirdly, at the empirical level analysis can also be conducted for cross-section of industries and to discover whether there are interesting results among firms in different industries.
Last but not least, when it comes to the relation between corporate performance and ownership concentration, there are few relative materials, and current studies are basically focus on executive compensation, leverage, takeover event and stock liquidity those four point of view. Obviously, it is beneficial of further exploration on other aspect of corporate performance, for instance, payout policy and investment strategy style.
This paper has organized a literature review on ownership concentration. The selected references, ranging from 1983 to 2007, cover theoretical, methodological and empirical evidence. The empirical evidence is well-organized and chosen include samples among different countries such as U.K. and U.S. The review consists of papers appearing in those famous financial journals, e.g. Journal of Finance, Journal of Financial Economics. Hence the report can be relied to be thorough and profound.
Began by its development and costs and benefits, the report then emphasize the relationship between ownership concentration and firm value plus firm performance. Corporate concentration is one of most common approach to solve agency problem
This paper classifies three reasons behind the development of ownership concentration, which are the shared benefits (block-holders have the inclination and control rights to manage a firm's investment which is shared with minority outside investors), the private benefits (block-holders tend to attain profits to the exclusion of outsider investors), and investor protection (ownership concentration becomes a substitute for legal protection).
Then costs and benefits of corporate concentration are presented in the paper. Ownership centralization is a mechanism can constrain company moral hazard, however, constrains on managers through regulaiton may be costly.
Moreover, it comes to the impact and effectiveness of corporate concentration by summary of previous literature on firm value, liquidity, executive compensation, and takeover frequency. We find that relationships between large-percent shareholders and these aspects are highly controversial based on different countries and research methods.
Lastly, this paper offers recommendations for further research in four aspects, which are the cross-national, cross-industries, institutional environment study and wider firm management exploration.
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These studies use different ownership measures blockholder ownership, officer and director ownership, insider ownership, share of largest owner, share of two largest owners, closely held shares, and the Herfindahl Index of Ownership concentration
Features Of Corporate Concentration
This table is designed to show the comparative features of corporate concentration and company performance among five different countries: U.S., U.K., Canada, France, and Germany.
Source: Eric R. Gedajlovic and Daniel M. Shapiro, 1998, Page. 537
A change of one standard deviation in blockholder ownership(1.87) would therefore have an effect of 0.015*1.87=0.028 on firm value, which is 4.5% of average Q, or 3.7% of a standard deviation in Q.” from Steen Thomsena,Torben Pedersena,Hans Kurt Kvist (2005)
Canada, France, Germany, the United Kingdom, and the United States
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