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Role of Management with Diffuse Ownership

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β€’ Diffuse stock ownership

– Limited liability public corporation

– Diffuse ownership of voting equity shares

– Large number of individual share owners

– Separation of ownership and control

β€’ Operations of firm are conducted and controlled by managers without major stock ownerships

β€’ Conflicts of interest arise between owners and managers


β€’ Equity ownership by managers must balance

– Convergence or alignment of interests

– Entrenchment considerations β€” managerial ownership and control of voting rights may allow pursuit of self-interest

β€’ Ownership and performance

– Stulz (1988)

β€’ Model in which at low levels of management ownership, increased equity holdings improve convergence β€” enhance firm value

β€’ At higher levels of insider ownership, managerial entrenchment prevents takeovers β€” decrease firm value

– Morck, Schleifer, and Vishny (MSV) (1988)

β€’ Study based on 1980 data

β€’ Performance (measured by q-ratio) related to management or insider ownership percentages

– Ownership concentration increased from 0 to 5%

β€’ Performance improved

β€’ Alignment-of-interest effect

β€’ Direction of causality may be reversed β€” high performance firms more likely to give managers stock bonuses

β€’ High performance firms may have substantial intangible assets that require greater ownership concentrations to induce proper use of these assets.

– Ownership concentration in range 5% to 25%

β€’ Performance deteriorated

β€’ Management entrenchment dampens performance

– Ownership concentration above 25%

β€’ Performance improved but slowly

β€’ Incremental entrenchment effects attenuated

– McConnell and Servaes (MS) (1990)

β€’ Replicate MSV study using 1976 and 1986 data

– For 1976, relationship between ownership concentration and performance relatively flat with moderate convergence of interest effect up to 50%, after which curve flattens and then declines moderately

– For 1986, relationship curve rises relatively sharply to 40%, after which it is relatively flat to 50% followed by sharp decline

β€’ Leverage, institutional ownership, R&D expenditures, and advertising Cho (1998)

β€’ Replicates MSV patterns using ordinary least square regressions and 1991 data

β€’ Tests for endogenous ownership structure

β€’ Finds that corporate value affects ownership structure, but not reverse

β€’ Bristow (1998)

β€’ Sample of consistently derived insider holdings on 4,000 firms during 1986-95

β€’ Relationship between management ownership and performance varies for each of the ten years

β€’ expenditures do not change initial findings

β€’ Economic variables influence ownership-performance relationship

– Relative growth rates of industries

– Differences in demand-supply relationships among industries

– Relative value change patterns among industries and firms within them

– Stock price movements

β€’ Interpretations of diverse data patterns

– May reflect economic identification problem discussed by Cho

– True relationship may be Demsetz-Lehn theory of no relationship between ownership level and performance

– Holderness, Kroszner, and Sheehan (1999)

β€’ Percentage of managerial equity ownership

– Mean increased from 12.9% in 1935 to 21.1% in 1995

– Median increased from 6.5% in 1935 to 14.4% in 1995

β€’ Doubling of managerial ownership may imply improvement in corporate governance in U.S.

– Managerial ownership and bond returns β€” Bagnani, Milonas, Saunders, and Travlos (1994)

– No relation between bond returns and managerial ownership below 5%

– Positive relation for managerial ownership between 5% and 25%

β€’ Increased incentives for managers to act in shareholders’ interest, taking risks that are potentially harmful to bondholders

β€’ Rational bondholders required higher returns

– Weak negative relation for ownership above 25%

β€’ Managers become more risk averse

β€’ Managers have high stake in firm β€” greater incentives to protect their private benefits and objectives

β€’ Managers’ interest more aligned with bondholders β€” lower bond premia

– Financial policy and ownership concentration

– Share repurchases financed by debt

β€’ Insider group does not tender its shares in repurchases β€” percentage equity shares increased

β€’ Increased convergence of interest effect

– Incentive effects of high management ownership percentages performed positive role in LBOs and MBOs

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