Ownership Structure, Managerial Behavior and Corporate Value

Topics: Stock market, Investment, Stock Pages: 24 (7926 words) Published: March 31, 2010
Journal of Corporate Finance 11 (2005) 645 – 660 www.elsevier.com/locate/econbase

Ownership structure, managerial behavior and corporate value J.R. Daviesa, David Hillierb,T, Patrick McColganc

University of Strathclyde, UK b University of Leeds, UK c University of Aberdeen, UK

Received 21 November 2002; accepted 6 July 2004 Available online 20 April 2005

Abstract The nonlinear relationship between corporate value and managerial ownership is well documented. This has been attributed to the onset of managerial entrenchment, which results in a decrease of corporate value for increasing levels of managerial holdings. We propose a new structure for this relationship that accounts for the effect of conflicting managerial incentives, and external and internal disciplinary monitoring mechanisms. Using this specification as the basis for our analysis, we provide evidence that the managerial ownership–corporate value relationship is co-deterministic. This finding is at odds with recent work which reports that corporate value determines managerial ownership but not vice-versa. D 2005 Elsevier B.V. All rights reserved. JEL classification: G32 Keywords: Ownership structure; Capital expenditure; Corporate value; Tobin’s Q

1. Introduction In a market without agency problems, corporate managers will choose investments that maximise the wealth of shareholders. In practice, competing objectives which are incompatible with the shareholder wealth-maximising paradigm may also be pursued. T Corresponding author. Leeds University Business School, University of Leeds, Maurice Keyworth Building Leeds, LS2 9JT, UK. Tel.: +44 113 3434359; fax: +44 113 3434459. E-mail address: d.j.hillier@Leeds.ac.uk (D. Hillier). 0929-1199/$ - see front matter D 2005 Elsevier B.V. All rights reserved. doi:10.1016/j.jcorpfin.2004.07.001


J.R. Davies et al. / Journal of Corporate Finance 11 (2005) 645–660

Following Jensen and Meckling (1976), a large literature has developed that examines how managerial behavior impacts upon firm performance. A vibrant strand of this literature concerns the relationship between managerial ownership levels, the direct investment decisions made by management and the inherent value of the firm, as proxied by Tobin’s Q ratio. Morck et al. (1988), McConnell and Servaes (1990), and Hermalin and Weisbach (1991) provide evidence of a significant nonlinear relationship between corporate value and managerial ownership. Specifically, value increases with managerial holdings for low levels of ownership. At some level, managers become entrenched within the firm resulting in a decrease in firm value. However, whereas Morck et al. (1988) and Hermalin and Weisbach (1991) document further changes in the corporate value–managerial holdings relationship at high levels of equity ownership, McConnell and Servaes (1990) report no such change. Recent work has built upon the findings of Demsetz and Lehn (1985) who argue that levels of managerial ownership will be determined endogenously in equilibrium. Moreover, Cho (1998) and Himmelberg et al. (1999) have shed doubt upon the earlier findings of Morck et al. (1988) and McConnell and Servaes (1990) by controlling for the effects of endogeneity and unobservable (to the econometrician) firm characteristics in their analysis. After controlling for the effects of endogeneity in the corporate value– managerial holdings relationship, they showed that managerial ownership had little or no effect on corporate value and investment. Short and Keasey (1999) and Faccio and Lasfer (1999) utilize a cubic specification to model the corporate value–managerial holdings relationship and both report a significant nonlinear functional form, similar to Morck et al. (1988), for British companies. However, neither study fully examines the misspecifying impact of endogeneity on their results. In this paper, we propose a new structure to the managerial ownership–corporate value relationship which...

References: Burkart, M., Gromb, D., Panunzi, F., 1997. Large shareholders, monitoring, and the value of the firm. Quarterly Journal of Economics 112, 693 – 728. Cho, M.H., 1998. Ownership structure, investment, and the corporate value: an empirical analysis. Journal of Financial Economics 47, 103 – 121. Chung, K.H., Pruitt, S.W., 1994. A simple approximation of Tobin’s Q. Financial Management 23, 70 – 74. Dahya, J., McConnell, J.J., Travlos, N.G., 2002. The Cadbury committee, corporate performance and top management turnover. Journal of Finance 57, 461 – 483. Demsetz, H., Lehn, K., 1985. The structure of corporate ownership: causes and consequences. Journal of Political Economy 93, 1155 – 1177. Demsetz, H., Villalonga, B., 2001. Ownership structure and corporate performance. Journal of Corporate Finance 7, 209 – 233. Denis, D.J., Sarin, A., 1999. Ownership and board structures in publicly traded corporations. Journal of Financial Economics 52, 187 – 223. Denis, D.J., Denis, D.K., Sarin, A., 1997. Ownership structure and top executive turnover. Journal of Financial Economics 45, 193 – 221. Doukas, J.A., McKnight, P.J., Pantzalis, C., 2002. Security analysis, agency costs and UK firm characteristics. Working Paper. Faccio, M., Lasfer, M.A., 1999. Managerial ownership, board structure and firm value: the UK evidence. Working Paper. Faccio, M., Lasfer, M.A., 2000. Do occupational pension funds monitor firms in which they hold large stakes? Journal of Corporate Finance 6, 71 – 110. Fama, E.F., 1980. Agency problems and the theory of the firm. Journal of Political Economy 88, 288 – 307. Franks, J., Mayer, C., 1996. Hostile takeovers and the correction of management failure. Journal of Financial Economics 40, 163 – 181. Franks, J., Mayer, C., Renneboog, L., 2001. Who disciplines management in poorly performing companies? Journal of Financial Intermediation 10, 209 – 248. Hart, O.D., 1983. The market mechanism as an incentive scheme. Bell Journal of Economics 14, 366 – 382. Hermalin, B., Weisbach, M., 1991. The effects of board composition and direct incentives on firm performance. Financial Management 20, 101 – 112. Himmelberg, C.P., Hubbard, R.G., Palia, D., 1999. Understanding the determinants of managerial ownership and the link between ownership and performance. Journal of Financial Economics 53, 353 – 384. Jensen, M.C., 1986. Agency costs of free cashflow, corporate finance and takeovers. American Economic Review 76, 323 – 329. Jensen, M.C., Meckling, W.H., 1976. Theory of the firm: managerial behavior, agency costs and ownership structure. Journal of Financial Economics 3, 305 – 360. Jensen, M.C., Ruback, R.S., 1983. The market for corporate control: the scientific evidence. Journal of Financial Economics 11, 5 – 50. Kole, S., 1995. Measuring managerial equity ownership: a comparison of sources of ownership data. Journal of Corporate Finance 1, 413 – 435. Lewellen, W.G., Badrinath, S.G., 1997. On the measurement of Tobin’s Q. Journal of Financial Economics 44, 77 – 122.
J.R. Davies et al. / Journal of Corporate Finance 11 (2005) 645–660
Lindenberg, E., Ross, S., 1981. Tobin’s Q ratio and the industrial organization. Journal of Business 54, 1 – 33. Martin, K.J., McConnell, J.J., 1991. Corporate performance, corporate takeovers, and management turnover. Journal of Finance 46, 671 – 687. McConnell, J.J., Servaes, H., 1990. Additional evidence on equity ownership and corporate value. Journal of Financial Economics 27, 595 – 612. Modigliani, F., Miller, M.H., 1963. Corporate income taxes and the cost of capital: a correction. American Economic Review 53, 433 – 443. Morck, R., Shleifer, A., Vishny, R.W., 1988. Management ownership and market valuation: an empirical analysis. Journal of Financial Economics 20, 293 – 315. Myers, S.C., 1977. Determinants of corporate borrowing. Journal of Financial Economics 5, 147 – 175. Roe, M.J., 1990. Political and legal restraints on ownership and control of public companies. Journal of Financial Economics 27, 7 – 42. Ross, S.A., 1977. The determination of financial structure: the incentive-signalling approach. Bell Journal of Economics 8, 23 – 40. Short, H., Keasey, K., 1999. Managerial ownership and the performance of firms: evidence from the UK. Journal of Corporate Finance 5, 79 – 101. Stulz, R.E., 1988. Managerial control of voting rights: financing policies and the market for corporate control. Journal of Financial Economics 20, 25 – 54.
Continue Reading

Please join StudyMode to read the full document

You May Also Find These Documents Helpful

  • Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure Essay
  • Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure Essay
  • Analysis
  • Ownership Structure and Corporate Voluntary Disclosure Essay
  • Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure Essay
  • Value Creation and Value Capture in Corporate Governance Essay
  • Corporate Structure: Securities Investors Association Essay
  • Corporate Financial Policy and the Value of Cash Essay

Become a StudyMode Member

Sign Up - It's Free