Print
E-MailThis post is from Cliff Holderness of Boston College.
One of the major findings of the law and finance literature comparing corporate governance across countries is that large-percentage shareholders in public corporations are a response to weak legal protections for investors. Thus, it is reported that common law countries have less concentrated ownership than civil law countries because they afford stronger legal protections for investors. Similarly, it is reported that ownership is less concentrated in countries with strong investor protection laws.
The papers that reach these conclusions analyze country averages of ownership concentration instead of firm-level data. I just released a paper in which I show that this creates omitted-variable and aggregation biases. Aggregation, in particular, eliminates all within-group (country) variation, leading to artificial clustering. Most papers also use small samples of large firms. This makes inferences to country populations problematic because ownership concentration is inversely related to firm size and firm size varies across countries.
I correct for these limitations by analyzing firm-level observations; control for firm-level determinants of ownership concentration, including size; and use a broad sample of firms from 32 countries. When I take these steps there is no support for the widely held theory that large shareholders are a response to weak legal protections for investors. In particular, there is no relation between ownership concentration and whether a firm comes from a common law country. Similarly, there is no systematic relation between ownership concentration and 14 broad indices of investor protection laws. An index is as likely to be positively associated with ownership concentration as it is to be negatively associated with ownership concentration.
Given these findings, I re-examine the theoretical literature that predicts a negative relation between investors’ legal protections and ownership concentration. There are two branches to this literature, and they have diametrically opposed views on the role of large shareholders in public corporations. One branch models external blockholders who monitor management to stop the appropriation of corporate resources. The problem is that around the world blockholders typically are managers. The other branch, in contrast, models internal blockholders who appropriate corporate resources. Although this comports with the reality that most blockholders are insiders, it is inconsistent with evidence showing that in most countries firm value increases with ownership concentration. Both branches of the literature ignore the effects of large shareholders on management decisions. Given how broadly large shareholders can impact management and given that management decisions are not subject to judicial review, even in countries with strong legal systems, there is no reason to expect ownership concentration to vary with investors’ legal protections.
The full paper is available here.
One Comment
Perhaps the findings of this study are not that astonishing considering the fact that it builds on a paper published by La Porta et al. This paper contains some serious flaws (see, e.g., Sofie Cools, The Real Difference in Corporate Law between the United States and Continental Europe: Distribution of Powers; Holger Spamann, Law and Finance Revisited, both available on SSRN). It is questionable that the study not even discusses the criticism with respect to La Porta et al., especially since the shortcomings could explain at least some of the evidence. Moreover, even if one takes La Porta et al. as basis, attention should be paid to the fact that this study was published ten years ago. During the period of the last ten years, European law and the law of many European countries underwent major changes in the legal environment. Thus, the question has to be asked if the current ownership structure examined in the study above should be scrutinized based on the legal data provided by La Porta et al. Another important point which was not part of the La Porta et al. paper is the tax environment. Ownership concentration is not understandable without taking taxes into view as well.