Controlling Shareholders

The second half of twentieth century witnessed a trend of increasing larger groups of shareholders as the favoured mechanism to counter the managerial agency problem (Bhagat et al., 2004). These large shareholders might be controlling blockholders or institutional investors who invest on behalf of others. Their stake in the corporation might be only a minority of the corporation’s outstanding shares but with enough shares under their control to dominate, or strongly influence, the board of directors, in turn, giving them the ability to choose management. These are known as controlling “dominant” shareholders[1] (Kostyuk et al., 2007).

LLSV (2002) show that the ownership structure of large corporations in 27 wealthy economies, except in economies with excellent legal shareholder protection (such as UK, USA, Canada and Hong Kong), is highly concentrated in the hands of large shareholders (large shareholders, blockholders and controlling shareholders shall be used interchangeably throughout this research).

Claessens et al. (2000), find that more than two-thirds of firms in nine East Asian countries are controlled by a single shareholder and that the management is very often related to the family of the controlling shareholder. According to Faccio and Lang (2002), families, who are the insiders in most of the civil law system countries, ultimately own about 45 per cent of more than 5,000 publicly listed Western European companies. Similarly, Laeven and Levine (2004) report that about one-third of 865 public firms in 13 Western European countries have two or more owners with 10 per cent or more of the voting rights each. Lins (2000) examines 1857 firms from 22 emerging markets and shows that 58 per cent of sample firms are controlled by one or more blockholders; and concluded that managers and their families are the dominant type of controlling blockholder in emerging markets. More recently and contrary to the general view that publicly-traded firms in the United States are diffusely owned, Holderness (2009) used a sample of U.S. firms to show that more than 95 per cent of these firms have one or more blockholders that on average own an aggregate share of 39 per cent.

This trend of a greater presence of large shareholder can contribute greatly to countering the managerial agency problem. Large shareholders, precisely because they own a large equity portion in the firm, possess sufficient control rights to effectively monitor and discipline management (Kostyuk et al., 2007).  As Shleifer and Vishny (1997) state:

Large shareholders […] address the agency problem in that they both have a general interest in profit maximisation, and enough control over the assets of the firm to have their interests respected. ( p. 754)

Accordingly, considerable attention has been focused on investigating how ownership structures can reduce agency problems between shareholders and managers and how the existence or absence of large shareholders can affect company performance (Shleifer and Vishny, 1986; Gilson and Black, 1995; Shleifer and Vishny, 1997). Shleifer and Vishny (1997) argue that large investors better monitor managers, they have better incentives to collect information and monitor management than small shareholders, and that they have enough voting power to make sure that management acts in the shareholders’ interests. They also suggest that the benefits from concentrated ownership may be relatively larger in countries that are generally less developed, where property rights are not well defined and/or protected and enforced by judicial systems. This may provide support to the question made by this thesis of whether legal protection contributes to equity market development within particularly vulnerable minority shareholder corporate environments, such as the MENA region where concentrated ownership is the prominent paradigm.

The role of controlling shareholders is widely recognized as a corporate governance arrangement. Many studies were conducted focusing on the positive relation between ownership concentration[2] and board turnover or restructuring of poorly performing firms.

Analysing unsuccessful takeovers in the U.S. during the 1983-89 period, Denis and Serrano (1996) found that high management turnover in poorly performing firms was linked to large shareholders existence. Denis et al., (1997) suggest that ownership structure has an important influence on internal monitoring efforts. They concluded that the top executive turnover is positively associated to the presence of large blockholders. They also note that turnover is more sensitive to performance when the firm has blockholders than when it does not.

In order to eliminate the CEOs’ compensation for observable luck (changes in firm performance that are not due to the performance of the CEO), Bertrand and Mullainathan (2001), test the ‘skimming’ hypothesis which posits that the CEO has sufficient power to construct their own pay scheme for their own advantage; while shareholders have, in fact, little to say concerning the way in which the CEO is compensated. The researchers indicate that ‘skimming’ is less likely to occur in cases where large shareholders are on the board.  They reported that better governed firms report less ‘skimming’ (better governed firms pay less for luck).  Similarly, Hartzell and Starks (2003) found that institutional investors might reduce the principal agent problem by serving as a monitor with regard to executive compensation. They examined 1,914 firms in the United States from 1992 to 1997 and found a positive relationship between ownership concentration and the pay-for-performance sensitivity of a firm’s executive compensation. Furthermore, they found that institutional ownership had a negative relationship with excess salaries.

In Germany, Franks and Mayer (1994) also found a large turnover of directors with the presence of large shareholders. Kaplan and Minton (1994) studied the effectiveness of boards in the Japanese non-financial corporations from 1980 to1988 and found that replacing directors increases when preceded by poor stock performance and earnings losses, and was more likely in firms with large shareholder, significant bank borrowings, and membership in a corporate group. Similarly, Kang and Shivdasani (1995) using data on 270 Japanese firms from 1985 to 1990, examined the effects of main banks, block holders, kieretsu groups, and outside directors on the relationship between top executive non-routine turnover and firm performance. They reported that large shareholders play a significant role in the likelihood that a new top executive will be appointed from outside the firm. They concluded that concentrated equity ownership performs an important governance role in Japan.

As the ownership stake of a controlling shareholder increases, they have a greater incentive to increase the firm’s value. Therefore, when trying to investigate whether dispersed ownership results in management acting less in the shareholders’ interests, analysts have often examined whether there exist relationships between ownership structure as the independent variable, and measures of company performance as the dependent variables, such as company valuation and accounting ratios of profitability (Lease et al., 1984, Shleifer and Vishny, 1986; Morck et al., 1988;  Agrawal and Knoeber 1996; Mehran, 1995). Empirical evidence, however, is mixed in this regard. Holderness and Sheehan’s (1988) report that the relationship is weak between blockholder identity and a firm’s equity value. Similarly, Agrawal and Knoeber (1996) highlight a weak relationship between large shareholders and firm value or rate of return. Mehran (1995) fails to find any relationships between large ownership by institutional investors, individuals or corporations and company value. Woidtke (2001) shows a positive relationship between large ownership by private pension funds in the U.S. and company value, which he attributes to the fact that the managers of these funds were rewarded for good performance. Furthermore, he finds a negative relationship between large ownership by activist public pension funds and company value, which he argues is due to the fact that these funds are run with political motives.

According to Shleifer and Vishny (1986), strict financial discipline created by ownership concentration, induces firms to improve their capital allocation, reduce unprofitable investments and ultimately exhibit higher performance.  Morck et al. (1988) find that up to 5 per cent management ownership is positively related to company value. Hovey et al. (2003) highlight a positive relationship between large ownership by legal persons and company value. Similarly, McConnel and Servaes (1990) indicate a positive relationship between large ownership by institutional investors and company value, which they attribute to institutional investors acting as monitors.

Although, existing research suggests that the presence of a controlling shareholder is not necessarily the best and is often associated with two major disadvantages: the potential collusion of large shareholders with management against smaller investors; and the reduced liquidity of secondary market (Becht et al., 2002); Shleifer and Vishny (1997, p. 758) argue that there is a fundamental problem associated with the presence of large shareholders. They represent their own interests, which will not coincide with the interests of other investors in the firm.

In the process of using his control rights to maximise his own welfare, the large investor can therefore redistribute wealth-in both efficient and inefficient ways- from others (Shleifer and Vishny, 1997, p. 758).

When a large investor, exercises his control rights for self-dealing transactions, firm-specific investments can be distorted at the expense of other investors. This situation could be exacerbated if the large investor’s control rights are substantially greater than their cash flow rights. This is possible particularly if large investors have superior voting rights attached to the equity they own by way of a pyramid structure (Shleifer and Vishny, 1997). Villalonga and Amit (2006) define this conflict as Agency Problem II.

Not all controlling shareholders are alike; although they could serve as a monitor for management performance, their presence may indeed be inefficient when expropriation of minority shareholders is involved (Gilson, 2005).

The presence of a controlling shareholder reduces the managerial agency problem, but at the cost that the private benefits of minority shareholder control.  Non-controlling shareholders will prefer the presence of a controlling shareholder so long as the benefits from reduction in managerial agency costs are greater than the costs of private benefits of the controlling shareholders (Gilson and Black, 1995). Thus, the debate now extends from a two-way conflict between management and shareholders, to a three-way conflict between controlling blockholders, managers and minority shareholders (Bergolf and Thadden, 1999). Using this general framework, we will discuss in the following section several definitions for potential private benefits of control, resulting from having controlling shareholders along with sources of such benefits, and finally examining different methods to measure the value of these benefits.


[1]. Previous studies (LLSV, 1999; Claessens et al., 2002; Faccio and Lang, 2002; Bertrand et al., 2002) defined control as at least 20 per cent of voting power.

[2] Most research has followed Demsetz and Lehn (1985) in measuring concentration with respect to a group of owners, usually as the total equity share held by the largest five or largest 20 investors. Prowse (1992) measures total share of the largest five owners, as do Hovey et al. (2003), and Claessens et al. (2002) focus on the largest shareholder alone. While other studies, measures concentration as the total ownership share of all managers and five per cent or greater blockholders (Wruck, 1989).


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