Managerial Ownership Dynamics and Firm Value

In our forthcoming Journal of Financial Economics paper, Managerial Ownership Dynamics and Firm Value, Rüdiger Fahlenbrach and I examine the dynamics of managerial ownership for American firms from 1988 through 2003 and their relation to changes in firm value. We find that the average and median annual change in managerial ownership during that period is negative. Further, we show that a firm that experiences a large change in ownership is substantially more likely to experience a decline in ownership than an increase. High past and concurrent stock returns make it more likely that a firm will experience a large decrease in managerial ownership. In contrast, there is little evidence that low past and concurrent stock returns increase the probability of large increases in managerial ownership. Strikingly, firm characteristics other than stock returns and stock liquidity, such as proxies for information asymmetry, are mostly unrelated to large decreases in managerial ownership driven by sales of shares by insiders.

The widely held view that higher managerial ownership is valuable for shareholders because it aligns the interests of managers better with those of shareholders would make one concerned about the implications of our finding of decreasing ownership for firm value. However, controlling for the determinants of ownership changes, we find no evidence that large decreases in managerial ownership reduce Tobin’s q. In contrast, we show that large increases in managerial ownership can be interpreted, in our experimental design, to cause increases in q. Using insider trading data and a decomposition of changes in managerial ownership, we show further that the positive relation between large increases in managerial ownership and changes in q is driven by increases in shares owned by officers rather than increases in shares owned by directors or changes in the number of shares outstanding.

Our findings suggest the following interpretation. Managers own shares to maximize their welfare subject to constraints and firms start their life with highly concentrated ownership. The highly concentrated ownership of young firms is partly explained by the fact that early in the life of the firm managerial ownership is a cheap form of financing for financially constrained firms. Later in the life of the firm, when the firm is doing well and their reputation has increased, managers start to reduce their stake to diversify. They do so in a way that does not endanger their position or reduce the value of their remaining shares. As a result, sales have little impact on firm value. By buying shares, managers bond themselves to pursuing policies that benefit minority shareholders more – at least as long as their ownership does not become so high that they become safe from removal. Managers buy shares when this bonding effect is valuable to them because it enables the firm to raise funds on better terms and reduces threats to their position. Managers also increase their holdings when the firm is financially constrained and they prevent the firm from becoming more constrained by receiving shares instead of cash.

The full paper is available for download here.