Reexamining the managerial ownership effect on firm value

Whether equity-based compensation and equity ownership align the interests of managers with stockholders is an important question in finance. Early studies found an inverted U-shaped relation between managerial ownership and firm value, but later studies using firm fixed effects found no relation. Managerial ownership levels change very slowly over time which may mask an ownership effect on firm value when using a fixed effect model. This is due to a much smaller within firm variation than between firm variation. We demonstrate that using pay-performance semi-elasticity, rather than pay-performance sensitivity as a measure of managerial ownership incentives, results in meaningful variation within firm over time. The greater within firm variation increases the power to detect a relation between managerial ownership and firm value with fixed effect regressions. As in the early research on this issue, we find a significant inverted U-shaped relation between managerial ownership and Tobin's Q in fixed effects regressions and after controlling for endogeneity with both two-stage and three-stage least squares regressions. Our results are consistent with incentive alignment at low levels and risk aversion at high levels of managerial ownership.     

Changes in insider ownership and changes in the market value of the firm

The empirically-observed cross-sectional relation between the level of insider share ownership and the level of firm value has often been interpreted to mean that a change in share ownership can lead to a change in firm value. Such an interpretation has been criticized for ignoring potential endogeneity. In this paper, we perform two sets of tests to circumvent this alleged endogeneity. First, we measure changes in value over the 6-day interval around announcements of insider share purchases and find that the cross-sectional variability in changes in value is described by a curvilinear relation between firm value and insider ownership where the value of the firm first increases, then decreases, as insider share ownership increases. Second, we conduct tests to determine (1) whether the insider purchases are a response to changes in firm characteristics that require a new optimal equilibrium ownership level or (2) whether insiders are purchasing shares to signal that the firm is undervalued. We find no evidence to support these interpretations. Overall, our results are consistent with a causal interpretation of the empirical relation between insider ownership and firm value.     

Insider Ownership and Firm Value: Evidence from Real Estate Investment Trusts

Real estate investment trust (REIT) provides a unique laboratory to study the relation between insider ownership and firm value. One, a REIT has to satisfy special regulations which weaken alternative mechanisms to control agency problems. Empirically, I find a significant and robust nonlinear relation between Tobin's Q and REIT insider ownership that is consistent with the trade-off between the incentive alignment and the entrenchment effect of insider ownership. Two, many REITs are Umbrella Partnership REITs (UPREITs) which have dual ownership structure. They have both common shares and Operating Partnership Units (OP units). Property owners can contribute their properties to the UPREIT in exchange for OP units. Their capital gains taxes remain deferred as long as they hold onto their OP units and the UPREIT does not sell the properties they contributed. OP units owners are locked in with the firm and have incentive to monitor firm management, but their interests diverge from the common shareholders because their tax bases are much lower. Consistent with the trade-off between positive monitoring effect of OP units and tax-induced agency costs, I find that UPREIT's firm value increases with the fraction of OP units, but the effect is significantly weaker for the UPREITs where insiders hold OP units.     

Investment Opportunity Set and Voluntary Disclosure of Prospective Information: A Simultaneous Equations Approach

Abstract:   This paper examines empirically the relationship between the level of disclosure of prospective information and the investment opportunity set for firms in New Zealand. Using a systems (two‐stage least squares) approach that explicitly controls for potential endogeneity between disclosure and IOS, we find that the level of prospective information disclosure is significantly and positively related to IOS in both specifications in our simultaneous analysis. Further, we document that prospective information disclosure is positively related to firm size and new security offerings, and is not related to inside ownership and firm profitability. IOS is positively impacted by a firm's investments in fixed assets and its profitability. Finally, we find that forward looking disclosure levels are positively related to the proportion of outside directors on the board and negatively related to barriers to entry, but these findings are not robust across alternative model specifications.     

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.     

MANAGERIAL OWNERSHIP CHANGE AND FIRM VALUE: EVIDENCE FROM DUAL-CLASS RECAPITALIZATIONS AND INSIDER TRADING

We explore the relation between managerial ownership and firm value by examining a sample of firms that announce dual-class recapitalizations and the insider trading activity that precedes these announcements. Insider trading activity, unlike recapitalization, requires managers to commit their personal wealth and therefore serves as an indicator of the motivation behind the recapitalization. The recapitalization, in effect, allows managers to magnify the increase in vote ownership that results from insider buying and offsets the decrease in vote ownership that results from insider selling. This study adds to our understanding of dual-class recapitalizations by linking the wealth effects and changes in ownership concentration with ***manager-shareholder agency issues that follow from recapitalization and insider trading activity. Results show a positive relation between the change in firm value and ownership for recapitalizations before the 1984 New York Stock Exchange moratorium on delisting dual-class firms when ownership was high and control was firmly established. Results show a negative relation for recapitalizations since 1984 when ownership levels were lower and voting control was not assured. These results support the notion that more recent recapitalizations entrench managers.     

Do managers seek control and entrenchment?

A unique dataset of post-IPO thrifts with heterogeneous initial insider ownership allows us to use revealed preferences to determine the level of ownership insiders believe to be optimal. We find strong evidence that insider ownership converges to the 20% to 30% range, whether insiders begin with diffuse or concentrated ownership. This range of ownership has been found consistent with entrenchment and control in the literature. Our results are robust to a battery of variables related to insider ownership such as moral hazard, adverse selection, market timing, insider characteristics, and firm characteristics. Furthermore, we find that managers with diffuse ownership accumulate shares most aggressively during the period of regulatory anti-takeover protection, consistent with an entrenchment motive. We find that managers with above-average pay are more likely to seek higher ownership, consistent with the existence of private benefits of control. Finally, we find that insider ownership determines equity issuance, leverage, and share liquidity in ways consistent with expected accumulation or reduction in insider ownership for control purposes.     

Multiple blockholders,power, and firm value

Using a comprehensive sample of US firms we show that most of them have multiple blockholders whose presence and ownership stakes lead to a significant difference between ownership and power. This difference matters. First, we find that insider power (ownership) is negatively (positively) related to firm value. Second, we show that outsider power is positively related to firm value. Our direct blockholder-level measure of power explains firm value over and above the explanatory power of firm-level measures used in the literature (such as the number of blockholders and the dispersion of their ownership stakes).     

BID-ASK SPREAD AND OWNERSHIP STRUCTURE

In this paper we examine the relation between bid-ask spread and ownership structure variables based on 1985 data for 1,063 NYSE firms. We document a nonpositive relation between bid-ask spread and insider ownership and conclude that spread is unrelated to insider trading. We also find a robust significantly negative relation between spread and institutional ownership. Finally, we find a positive but generally insignificant relation between spread and blockholdings. Overall, our evidence does not support the predictions of asymmetric information models in markets with anonymous trading.     

On institutional ownership and firm performance: A disaggregated view

We study the relationship between institutional ownership and firm performance in Finland. A systems approach is employed to investigate the potential two-way causality between firm performance and ownership structure. Three-stage least squares estimation technique is used to solve for the systems. The evidence suggests an endogeneity problem between firm performance and institutional ownership. However, the magnitude of the problem differs with respect to the concentration of ownership measure used. Our results show that a more equal distribution of the voting power among the largest institutional stakeholder may exert positive effects on firm performance. We also find a significant difference relating to firm performances and equity ownerships between the two classes of institutional investor. Consistent with the ownership structure in Finland, we find that a simple ownership concentration index does not influence firm performance.     

THE RISE IN MANAGERIAL STOCK OWNERSHIP

Despite the widespread view from Berle and Means onward that ownership of U.S. companies has become increasingly separated from managerial control, the authors report that managerial ownership of public corporations is markedly higher today than in 1935. Using a comprehensive sample of the 1,500 publicly traded firms in 1935 and a comparable sample of 4,200 firms in 1995, their study finds that managerial ownership increased from an average of 13% in 1935 to 21% in 1995. In terms of real (1995) dollar values, average managerial ownership increased from $18 million to $73 million over the same 60‐year period. One potential explanation for this increase is that greater reliance on managerial ownership has substituted for less reliance on other incentive alignment devices, such as pay‐for performance and the market for corporate control. The authors, however, report just the opposite. The use of such other corporate governance mechanisms has generally also increased over time, suggesting that the top managements of today's publicly traded corporations face greater pressure from investors and boards of directors than managements earlier in the century. An alternative explanation concern possible changes over time in the effects of certain company characteristics on the costs and benefits of using managerial ownership as a control device. While most of the characteristics the authors examined had the same relationship to managerial ownership in both periods, the role of volatility was different. In 1935, managerial ownership was inversely related to firm volatility; that is, higher volatility was associated with lower managerial ownership. In 1995, however, the relationship of managerial ownership to volatility was “nonlinear”; managerial ownership was positively related to firm volatility at low and moderate levels of volatility but the relationship turns negative when firm volatility is high. The overall lower level of volatility today, together with advances in capital markets and financial theory that have reduced the costs of hedging, appear to have reduced the costs of managers holding large stakes in their firms.     

Insider ownership and corporate performance: Evidence from the adjustment cost approach

This paper examines the relation between insider ownership and corporate performance in the presence of adjustment costs and investigates how the adjustment costs are determined. In a model specification without adjustment costs, we find that insider ownership is significantly positively associated with corporate performance. But once we allow for adjustment costs, the relationship no longer exists. We find that insider ownership and corporate performance can be explained by their respective lagged values and that many firm characteristics that were previously useful in explaining these two variables turn out to be statistically insignificant. In addition, there is no evidence that insider ownership and corporate performance affect each other. This is consistent with the adjustment cost argument. It is also consistent with the “endogeneity” argument suggested by Demsetz [Demsetz, H. 1983. The structure of ownership and the theory of the firm. Journal of Law and Economics 26, 375–390.], Demsetz and Lehn [Demsetz, H., Lehn, K., 1985. The structure of corporate ownership: causes and consequences. Journal of Political Economy 93, 1155–1177.], and Demsetz and Villalonga [Demsetz, H., Villalonga, B., 2001. The ownership structure and corporate performance. Journal of Corporate Finance 7, 209–233.]. Finally, we document that the speed of adjustment of insider ownership is positively related to insiders' market timing but negatively to the number of insiders and that the speed of adjustment of Tobin's Q is positively associated with financial leverage and stock price volatility.     

Insider ownership, ownership concentration and investment performance: An international comparison

This article makes two important contributions to the literature on the incentive effects of insider ownership. First, it presents a clean method for separating the positive wealth effect of insider ownership from the negative entrenchment effect, which can be applied to samples of companies from the US and any other country. Second, it measures the effects of insider ownership using a measure of firm performance, namely a marginal q, which ensures that the causal relationship estimated runs from ownership to performance. The article applies this method to a large sample of publicly listed firms from the Anglo-Saxon and Civil law traditions and confirms that managerial entrenchment has an unambiguous negative effect on firm performance as measured by both Tobin's (average) q and our marginal q, and that the wealth effect of insider ownership is unambiguously positive for both measures. We also test for the effects of ownership concentration for other categories of owners and find that while institutional ownership improves the performance in the USA, financial institutions have a negative impact in other Anglo-Saxon countries and in Europe.     

Blockholder ownership: Effects on firm value in market and control based governance systems

In this study, Granger tests are used to examine the relationship between blockholder ownership and the values of the largest companies in the European Union and the US. Previous studies on US data have found that blockholder ownership has no systematic effect on performance. We propose that these results may not apply to Continental Europe, where ownership concentration is typically higher, the level of investor protection is lower, and influential blockholders may have objectives other than shareholder value. In accordance with previous research, we find no significant association between blockholder ownership and prior or subsequent firm value in either the US or the UK. Nonetheless, in Continental Europe we find a negative association between blockholder ownership and firm value or accounting returns in the next period. Further analysis reveals that this association is significant only for companies with high initial levels of blockholder ownership (> 10%). We interpret this finding as evidence of conflicts of interest between blockholders and minority investors. The percentage of blockholder ownership in Continental Europe may be too high from a minority shareholder value viewpoint.     

Insider ownership and signals: evidence from stock split announcement effects

This study examines whether investors regard the level of insider ownership of a firm as useful for evaluating stock split decisions. Results show that the abnormal returns at the announcement of stock splits are positively related to the level of insider ownership. The results prevail even after controlling for other relevant factors. Further analysis indicates the positive relation exists for small firms, but not for large firms. This indicates the market evaluates stock split decisions within the context of both insider ownership and information asymmetry.     

Managerial hedging,equity ownership,and firm value

Suppose risk‐averse managers can hedge the aggregate component of their exposure to firm's cash‐flow risk by trading in financial markets but cannot hedge their firm‐specific exposure. This gives them incentives to pass up firm‐specific projects in favor of standard projects that contain greater aggregate risk. Such forms of moral hazard give rise to excessive aggregate risk in stock markets. In this context, optimal managerial contracts induce a relationship between managerial ownership and (i) aggregate risk in the firm's cash flows, as well as (ii) firm value. We show that this can help explain the shape of the empirically documented relationship between ownership and firm performance.     

Insider Ownership and Risk–taking Behaviour at Bank Holding Companies

This paper investigates the relationship between bank ownership structure and risk–taking. We find robust evidence that the greater risk taking incentives of stockholder controlled banks (compared to managerially controlled banks) are more pronounced for the set of banks with larger asset size, lower stock–return volatility, and lower balance–sheet–risk characteristics. Considering that the probability of failure for these banks is relatively low, these results may suggest that the efficacy of insider ownership in mitigating the agency problem could be affected by the costs perceived by the managers associated with aligning their interests with outside stockholders (i.e., the expected loss of benefits from control of the firm in the event of failure).     

Does ownership structure affect value? A panel data analysis for the Spanish market

This paper analyzes the influence of ownership structure on firm value. We find a non-significant relationship between the ownership of large blockholders and firm value. We also find a positive effect of the degree of control with regard to firm value. Endogenous treatment of these variables then reveals a positive effect for the ownership by major shareholders on firm value, although the opposite relationship is not significant; and a positive effect of the degree of control on Tobin's Q and vice versa. A positive effect is seen when the major shareholders are individuals.     

The Relationship Between Market Efficiency and Insider Ownership in Large and Small Firms

The study examines insider ownership in large and small firms in relation to market efficiency. Recent studies have found a positive and significant relation between inside ownership and stock market performance. Such a finding is predicated upon the idea that inside ownership minimizes agency costs caused by the conflict between hired managers and shareholders. It is argued here that semi-strong form market efficiency requires that all public information, including insider ownership, be quickly impounded into the price of a stock. If that is the case, the expected present value of a change in agency cost should be incorporated into the stock price shortly after any significant change in ownership. Hence, if the estimate is unbiased, the longer-term performance of firms should not be effected by such changes. The issue is examined for both large, well-known firms and for smaller, less-known firms. The hypothesis that markets are generally efficient with respect to insider ownership information is rejected.