The effect of ownership structure on firm performance: Additional evidence

This article examines the effect of ownership structure on corporate performance, using stock returns as a measure of performance. Based on the 1988–1992 sample period, we find that the level of insider ownership is positively related to stock returns. This result suggests that as managers' equity ownership increases, their interests coincide more with those of outside shareholders. But we also find that the square of the level of insider ownership is inversely related to stock returns, indicating that excessive insider ownership rather hurts corporate performance probably due to the problem associated with managers' entrenchment. Finally, we find that stock returns are positively related to institutional ownership, indicating that institutional owners are active in monitoring management.     

The relationship between managerial ownership and firm performance in high R&D firms

Several studies have examined the relationship between managerial ownership and firm performance/value (e.g., [Journal of Financial Economics 20 (1988) 293; Journal of Financial Economics 27 (1990) 595; Journal of Corporate Finance 5 (1999) 79]). Using different samples, these studies provide general support for the argument that increases in managerial ownership create countervailing interest alignment and entrenchment effects, leading to a nonlinear relationship between managerial ownership and firm performance. However, the actual form of this nonlinear relationship differs across the studies.The present paper examines the relationship between managerial ownership and performance for high R&D firms that are listed on the NYSE, AMEX and NASDAQ. We find that Tobin's Q initially declines with managerial ownership, then increases, then declines again and, finally, increases again—a W-shaped relationship. The findings from our study point to the importance of industry effects in the relationship between managerial ownership and firm performance.     

Determinants of Intercorporate Shareholdings

This paper examines why firms choose to spend resources on acquiring ownership rights in other firms. Based on a unique data base of every individual intercorporate shareholding on the Oslo Stock Exchange during the period 1980–1994, we find that such investments serve at least three functions. First, they play a role incorporate governance, as managers in firms withlow insider holdings, diffuse ownership structure and high free cash flow tend to mutually acquire equity stakes in each other, possibly in a collective attempt to protect their human capital in the market for corporate control. Second, interfirm equity holdings serve as financial slack for growing firms, reducing potential adverse selection costs by providing an internal funding source for new investments in long-term assets. Finally, our findings also suggest that intercorporate shareholdings are an integrated part of the investor's cash flow management system by being a liquidity buffer when cash inflows andcash outflows are non-synchronous.     

Corporate governance and firm performance

How is corporate governance measured? What is the relationship between corporate governance and performance? This paper sheds light on these questions while taking into account the endogeneity of the relationships among corporate governance, corporate performance, corporate capital structure, and corporate ownership structure. We make three additional contributions to the literature:First, we find that better governance as measured by the Gompers, Ishii, and Metrick [Gompers, P.A., Ishii, J.L., and Metrick, A., 2003, Corporate governance and equity prices, Quarterly Journal of Economics 118(1), 107–155.] and Bebchuk, Cohen and Ferrell [Bebchuk, L., Cohen, A., and Ferrell, A., 2004, What matters in corporate governance?, Working paper, Harvard Law School] indices, stock ownership of board members, and CEO-Chair separation is significantly positively correlated with better contemporaneous and subsequent operating performance.Second, contrary to claims in GIM and BCF, none of the governance measures are correlated with future stock market performance. In several instances inferences regarding the (stock market) performance and governance relationship do depend on whether or not one takes into account the endogenous nature of the relationship between governance and (stock market) performance.Third, given poor firm performance, the probability of disciplinary management turnover is positively correlated with stock ownership of board members, and board independence. However, better governed firms as measured by the GIM and BCF indices are less likely to experience disciplinary management turnover in spite of their poor performance.     

Institutional ownership and firm performance: The case of bidder returns

We employ corporate takeover decisions to investigate the impact of institutional ownership on corporate performance. The OLS regressions of bidder gains on institutional ownership indicate a positive relation between the two. However, we find institutional ownership to be significantly determined by firm size, insider ownership and the firm's presence in the S&P 500 index. Thus, when bidder gains are regressed on the predicted values of institutional ownership in two-stage regressions, the recursive estimates do not confirm the relationship shown by the OLS regressions. Furthermore, we do not find any evidence that active institutional investors (e.g., CalPERS) as a group enhance efficiency in the market for corporate control. These findings cast doubt on the superior selection/monitoring abilities of institutional investors.     

tay's as good as cay: Reply

In a recent comment on our published work [Lettau, M., Ludvigson, S., 2001. Consumption, aggregate wealth, and expected stock returns. Journal of Finance 56, 815–850], Michael Brennan and Yihong Xia [2005. tay's as good as cay. Finance Research Letters 2, 1–14] advance the following argument: A “mechanistic” variable tay, where t is a linear time trend, forecasts stock returns. Since “t has no foresight,” the argument goes, the predictive power of this variable must be attributable to what they call “look-ahead bias.” The authors assert that cay is subject to the same look-ahead bias (generated because we use the full sample to estimate the cointegrating parameters in cay), implying that its forecasting power must be spurious. In this response, we explain why this critique is misplaced.     

Asset pricing models with errors-in-variables

This paper revisits Fama and French [Fama, Eugene F., French, Kenneth R., (1993) Common risk factors in the returns on stock and bonds. Journal of Financial Economics 33 (1), 3–56] and Carhart [Carhart, Mark M., 1997. On persistence in mutual fund performance. Journal of Finance 52 (1), 57–82] multifactor model taking into account the possibility of errors-in-variables. In their well known paper, Fama and French [Fama, Eugene F., French, Kenneth R., 1997. Industry costs of equity. Journal of Financial Economic 43 (2), 153–193] concluded that estimates of the cost of equity for the three-factor model of FF (1993) were imprecise. We argue that this imprecision is even more severe because of the pervasive effects of measurement errors. We propose Dagenais and Dagenais [Dagenais, Marcel G., Dagenais, Denyse L., 1997. Higher moment estimators for linear regression models with errors in the variables. Journal of Econometrics 76 (1–2), 193–221] higher moments estimator as a solution. Our results show that estimates of the cost of equity obtained with Dagenais and Dagenais estimator differ sharply from popular OLS estimates and shed a new light on performance attribution and abnormal performance (α). Adapting the Generalized Treynor Ratio, recently developed by Hübner [Hübner, Georges, 2005. The generalized treynor ratio. Review of Finance 9 (3), 415–435], we show that the performance of managed portfolios with multi-index models should be revisited in presence of errors-in-variables.     

Costly external financing, investment timing, and investment–cash flow sensitivity

This paper examines the effects of costly external financing on the optimal timing of a firm's investment. By altering the optimal investment timing, costly financing affects current investment and the sensitivity of investment to internal cash flow. Importantly, the relation between the cost of external funds and investment–cash flow sensitivity is non-monotonic. Investment–cash flow sensitivity is decreasing in the cost of external financing when it is relatively low and is increasing in the financing cost when it is high. Empirical tests examining investment–cash flow sensitivities within groups of firms classified by proxies for their costs of external funds provide evidence consistent with the model. The model and the empirical results complement recent studies by Cleary, Povel and Raith [Cleary, S., Povel, P. and Raith, M., 2007. The U-shaped investment curve: theory and evidence, Journal of Financial and Quantitative Analysis 42, 1–39.] and Almeida and Campello [Almeida, H. and Campello, M., in press, Financial constraints, asset tangibility and corporate investment, Review of Financial Studies.] that show a non-monotonic relation between firms' investment and the availability of internal funds.     

Hedging errors with Leland's option model in the presence of transaction costs

Nonzero transaction costs invalidate the Black–Scholes [1973. Journal of Political Economy 81, 637–654] arbitrage argument based on continuous trading. Leland [1985. Journal of Finance 40, 1283–1301] developed a hedging strategy which modifies the Black–Scholes hedging strategy with a volatility adjusted by the length of the rebalance interval and the rate of the proportional transaction cost. Kabanov and Safarian [1997. Finance and Stochastics 1, 239–250] calculated the limiting hedging error of the Leland strategy and pointed out that it is nonzero for the approximate pricing of an European call option, in contradiction to Leland's claim. As a further contribution, we first identify the mathematical flaw in the argument of Leland's claim and then quantify the expected percentage of hedging losses in terms of the hedging frequency and the level of the option strike price.     

Effect of ownership,governance, and transparency on liquidity – Chilean evidence

Companies with relatively thin trading, a high concentration of insider ownership, and a privatized pension system characterize Chile’s Santiago Stock Exchange. Within this setting, we study the relationship between ownership concentration, corporate governance, and stock market liquidity. Our results suggest that board independence, corporate disclosure and outside monitoring by institutions help moderate the effects that insiders have on trading costs and liquidity. We also find that market makers with inventory reduce the informational component of trading costs. Finally, the trades of insiders provide price guidance to market makers, while traders employ a follow-the-insider strategy when transparency is low.     

The impact of geographic diversification on firm performance

This paper empirically examines the economic effects of both corporate industrial and geographic diversifications. Using a sample of 28,050 firm-year observations from 1990 to 1998, we find that industrial and geographic diversifications are associated with firm value decrease. Consistent with Denis et al. [Denis, D. J., Denis, D. K., and Yost, K. (2002). Global diversification, industrial diversification, and firm value. Journal of Finance, 57, 1951-1979], the costs of corporate diversification may outweigh the benefits of diversification. We find that geographically diversified firms have higher R&D expenditures, advertising expenses, operating income, ROE and ROA than industrially diversified firms. In addition, higher R&D expenditures create value for multi-segment global firms, but not for single-segment global firms. This result implies that there exists an interaction effect between industrial and geographic diversification. We also examine the effects of agency cost issues, as characterized by the diversification discount, on both industrial and geographic diversification. Consistent with the agency explanation, firms with high equity-based compensation are associated with higher firm value than firms with low equity-based compensation. Also, we find that firms with a higher insider ownership percentage are associated with higher excess value.     

Why Do Firms Become Widely Held? An Analysis of the Dynamics of Corporate Ownership

We examine the evolution of insider ownership of IPO firms from 1970 to 2001 to understand how U.S. firms become widely held. A majority of these firms has insider ownership below 20% after 10 years. Stock market performance and liquidity play an extremely important role in ownership dynamics. Firms with stocks that are highly valued, are liquid, and have performed well experience large decreases in insider ownership and become widely held. Ownership also falls for low cash flow and high capital expenditures firms. Surprisingly, variables proxying for agency costs have limited success in explaining the evolution of insider ownership.     

The impact of corporate governance on auditor choice: Evidence from China

As the largest and fastest growing emerging market, China is becoming more and more important to investors throughout the world. The purpose of this paper is to investigate the determinants of firms’ auditor choice in China in respect of their corporate governance mechanism. Normally firms have to take a trade-off in their auditor choice decisions, i.e., to hire high-quality auditors to signal effective audit monitoring and good corporate governance to lower their capital raising costs, or to select low-quality auditors with less effective audit monitoring in order to reap private benefits derived from weak corporate governance and less-transparent disclosure (the opaqueness gains). We develop a logit regression model to test the impact of firms’ internal corporate governance mechanism on auditor choice decisions made by IPO firms getting listed during a bear market period of 2001–2004 in China. Three variables are used to proxy for firms’ internal corporate governance mechanism, i.e., the ownership concentration, the size of the supervisory board (SB), and the duality of CEO and chairman of board of directors (BoDs). We classify all auditors in China into large auditors (Top 10) and others (non-Top 10), assuming the large auditors can provide higher quality audit services. The empirical results show that firms with larger controlling shareholders, with smaller size of SB, or in which CEO and BoDs chairman are the same person, are less likely to hire a Top 10 (high-quality) auditor. This suggests that when benefits from lowering capital raising costs are trivial, firms with weaker internal corporate governance mechanism are inclined to choose a low-quality auditor so as to capture and sustain their opaqueness gains. On the other hand, with improvement of corporate governance, firms should be more likely to appoint high-quality auditors.     

Forecasting asymmetries in aggregate stock market returns: Evidence from conditional skewness

This paper provides a time-series test for the Differences-of-Opinion theory proposed by Hong and Stein (2003) [Hong, H., Stein, J.C., 2003. Differences of opinion, short-sales constraints and market crashes. Review of Financial Studies 16, 487–525.] in the aggregate market, thus extending the cross-sectional test of Chen et al. (2001) [Chen, J., Hong, H., Stein, J.C.. 2001. Forecasting crashes: trading volume, past returns and conditional skewness in stock prices. Journal of Financial Economics 61, 345–381.] for this theory across individual stocks. An autoregressive conditional density model with a skewed-t distribution is used to estimate the effects of past trading volume on return asymmetry. Using NYSE and AMEX data from 1962 to 2000, we find that the prediction of the Hong–Stein model that negative skewness will be most pronounced under high trading volume conditions is not supported in our time-series analysis with market data.     

Corporate governance, insider ownership and operating performance of Australian initial public offerings

We examine ownership structures and corporate governance attributes of 313 Australian initial public offerings (IPOs) between 1976 and 1993 and their relation with up to 5 years of post‐listing operating performance, adjusted for similar (non‐IPO) firms. Consistent with prior share price‐based evidence, we find that the operating performance of Australian IPOs typically deteriorates over the first 4 post‐listing years. Any evidence of a positive association between insider ownership and firm performance is confined to the fourth and fifth years after the IPO. Evidence of a positive relation between institutional ownership and performance is restricted to the latter part of our 5‐year post‐listing window. Board composition (i.e. outsider versus insider control) is not associated with operating performance, although there is some evidence that independent board leadership is associated with better operating performance.     

SEASONED EQUITY OFFERINGS FOR NEW INVESTMENT AND THE INFORMATION CONTENT OF INSIDER TRADES

Significant negative valuation effects are widely acknowledged for firms announcing seasoned equity offerings. This result is consistent with theoretical models linking new equity issues to increased adverse-selection costs, lower management ownership in the firm, misuse of free cash flow, or expectations for earnings declines. Also increasingly evident, insiders trade around corporate announcements. We test the hypothesis that insider trading and announcements of new equity issues serve as joint signals in the market's evaluation of prospective capital investment projects. Our findings are consistent with the hypothesis that insider trading is related to market reaction to announcements of new equity issues.     

Transaction cost, corporate governance and division of labor—A general equilibrium analysis of professional managers and its implication to China's practice

This paper develops a Walrasian general equilibrium model based on transaction cost and specialization to investigate the emergence and evolution of the role of management services in a competitive market with the general concern of corporate governance. It explains the reason why along the commercialization and modernization of human society, there is substantial increment of professional managers available for business world, and also becoming more affordable for more business companies. With the improvement of transaction efficiency, the market demand of professional managers are more preferred and profitable, which will also bring about new business structures and new economic institutional systems to improve the well-being to the overall members of society. Thereby, hiring professional managers in a competitive market can promote aggregate productivity by enlarging the scope for trading off network effects of the division of labor on aggregate productivity against transaction costs. To business practitioners, this model suggests hiring professional managers a key element of business viability during that a major transition took place in human society. China's recent practices in ownership transformation and corporate governance have also been examined, which further proves our argument that performance and effectiveness of interaction and interrelation between ownership and corporate governance are endogenously determined by different market conditions. It is impossible to achieve success ownership transformation and establish effective corporate governance without upgraded changes and consecutive adjustment and improvement of market conditions to facilitate the solid function of market mechanism.     

Recapitalization of one class of common stock into dual-class: Growth and long-run stock returns

We study a sample of 178 firms that changed from a one-share one-vote into a dual-class common stock structure during 1979–1998. We find that dual-class recapitalizations are shareholder value enhancing corporate initiatives. Using accounting data, Lehn et al. (1990) [Lehn, K., Netter, J., Poulsen, A., 1990. Consolidating corporate control: dual-class recapitalizations versus leveraged buyouts. Journal of Financial Economics 27, 557–580] provide evidence that dual-class recapitalizing firms grow faster than firms in a control group and undertake secondary equity offerings (SEOs) to finance growth. We show that growth is indeed beneficial to the shareholders. The stockholders, on average, earn significant positive abnormal returns of 23.11% in a period of 4 years following the announcement month. Furthermore, abnormal returns are even larger (52.61%) for the dual-class firms that issue equity. This evidence is especially supportive of the value enhancing hypothesis as it is contrary to the prevailing result that SEOs are generally followed by large negative returns. We do not find any evidence of managerial entrenchment.     

Management succession and financial performance of family controlled firms

This paper examines the immediate and long-term impacts on financial performance of 124 management successions within Canadian family controlled firms. When family successors are appointed, stock prices decline by 3.20% during the 3-day (−1 to +1) event window, whereas there is no significant decrease when either non-family insiders or outsiders are appointed. However, a cross-sectional analysis indicates that the negative stock market reaction to family successors is related to their relatively young age which may reflect a lack of management experience rather than their family connection per se. Investors are uncertain about the “management quality” of family successors who have less established reputations than more seasoned non-family insiders and outsiders. Non-family member appointments tend to follow periods of poor operating performance implying that there might be more scope for improvement when a non-family successor is appointed. Unlike the US sample in McConaughy et al. [McConaughy, D.L., Walker, M.C., Henderson, G.V., Mishra, C.S., 1998. Founding family controlled firms: efficiency and value, Review of Financial Economics 7, 1–19.], which indicates that the median percentage of votes held by controlling families is less than 15%, the Canadian sample indicates a more concentrated ownership with the median percentage of family controlled votes exceeding 51%. Of the firms in our sample, 62% use dual class capitalization to maintain control within the family.     

An “American Dream” theory of corporate executive Fraud

In this paper, we first describe a “Broken Trust” theory that was introduced by Albrecht el al. [Albrecht, W. S., Albrecht, C. C., & Albrecht, C. O. (2004). Fraud and corporate executives: Agency, Stewardship and Broken Trust. Journal of Forensic Accounting, 5, 109–130] to explain corporate executive Fraud. The Broken Trust theory is primarily based on an “Agency” theory from economic literature and a “Stewardship” theory from psychology literature. We next describe an “American Dream” theory from sociology literature to complement Albrecht el al.'s (2004) Broken Trust theory. Like the Broken Trust theory, the American Dream theory relates to a “Fraud Triangle” concept to explain corporate executive Fraud. Finally, we provide some anecdotal evidence from recent high profile corporate executive Fraud to explore the American Dream theory. We conclude our thoughts on corporate executive Fraud from a teaching perspective.