Founders, Heirs, and Corporate Opacity in the U.S.

In our forthcoming Journal of Financial Economics paper entitled Founders, Heirs, and Corporate Opacity in the U.S., we investigate the impact of founder and heir shareholders on corporate opacity and whether, and how, they use their influence to affect firm performance.

We argue that founders’ and heirs’ unique and dominant control positions provide particularly strong incentives to diminish corporate transparency. We explore two hypotheses with regard to these controlling shareholders and transparency. Our first hypothesis centers on the notion that founders and heirs affect corporate transparency to entrench themselves and extract private benefits of control. However, a plausible alternative is that large shareholders have the incentive to collect information and the power to monitor managers. As a result, founders or heirs, acting as committed monitors with relatively undiversified stakes in the firm, may provide control and oversight that substitute for the disciplinary role of transparency. Further, if these controlling shareholders act as effective monitors, corporate opacity potentially provides competitive and cost advantages to the firm. Both the monitoring and entrenchment arguments suggest a positive relation between founder and/or heir shareholders and corporate opacity. However, the entrenchment hypothesis suggests corporate opacity allows these controlling shareholders to accrue private benefits of control. To differentiate between these non-mutually exclusive arguments, we examine whether the interaction of founder and/or heir ownership and corporate opacity affects outside shareholder wealth.

We test these arguments using the 2,000 largest U.S. firms from 2001 through 2003. Of our total sample, founder-controlled firms constitute 22.3% and heir-controlled firms comprise 25.3% with average equity stakes of approximately 18% and 22%, respectively. The analysis further indicates that founder controlled firms tend to be smaller, riskier, and more R&D intensive than manager or heir controlled firms. We develop an opacity index to gauge the relative opaqueness of our sample firms and find that both founder and heir ownership exhibit a significant and positive relation to opacity. We also find that founder and heir controlled firms exhibit a negative relation to performance in all but the most transparent firms. Surprisingly, additional tests reveal that concerns about divergences in ownership versus control management type, dual class shares, and board influence appear to be substantially less important than corporate opacity in explaining the performance impacts of founder and heir control. Finally, we decompose corporate opacity into disclosure and market scrutiny components, finding that the disclosure quality component appears to be of greater importance to investors. However, irrespective of whether these controlling shareholders create and/or stay in the firm because of corporate opacity, our analysis suggests that founders and heirs in large, publicly traded firms exploit opacity to extract private benefits at the expense of minority investors.

The full paper is available for download here.