Print
E-MailThis post comes to us from Bo Becker, Assistant Professor of Finance at Harvard Business School; Henrik Cronqvist, McMahon Family Chair in Corporate Finance, George R. Roberts Fellow, and Associate Professor of Financial Economics at Claremont McKenna College; and Rüdiger Fahlenbrach, Swiss Finance Institute Professor at Ecole Polytechnique Fédérale de Lausanne.
In our paper, Estimating the Effects of Large Shareholders Using a Geographic Instrument, forthcoming in the Journal of Financial and Quantitative Analysis, we develop and test a new instrumental variable framework which allows us to separate selection effects from treatment effects for a large group of blockholders and to quantify their impact on several aspects of firm behavior. We start by documenting that non-managerial individual shareholders hold blocks in firms that are headquartered close to where they live. We then use this empirical fact to create an instrumental variable (the geographic variation in the density of wealthy individuals) for the presence of a large shareholder in a publicly traded U.S. firm. This instrument predicts the presence of a block in a firm with surprising power, and it is robust to the inclusion of variables that vary geographically, reducing concerns about its validity.
Our evidence contributes in three ways to existing research on blockholders and more generally to corporate governance research. First, we find that blocks are not randomly allocated to firms, but are systematically allocated based on where the benefits to additional monitoring are more significant. This result confirms a suspicion about block ownership endogeneity that researchers have had at least since Demsetz and Lehn (1985). Importantly, the non-randomness of blocks matters. The inferences about the impact of large shareholders change significantly once we control for selection effects.
After controlling for block selection effects, we find that large shareholders affect a broad set of firm policies in addition to performance. The presence of a large shareholder reduces the firm’s investments, reduces corporate cash holdings, increases payouts to shareholders, and reduces total top executive pay. These results are economically and statistically significant. Firms with blockholders are also found to have more outside directors on their boards. Many theories predict that large shareholders mitigate agency problems between managers and owners by monitoring of management, and the presence of blocks is correlated with good governance, but our paper is among first to show that blocks actually cause the changes in firm behavior.
Finally, we find that large shareholders come with costs as well as benefits. While large shareholders are improving firm performance through monitoring, we also find costs of their presence to other shareholders. One cost is a less liquid publicly traded stock because of a smaller float, and because the presence of privately informed blockholders who might sell, increases informational asymmetries and as a result increases illiquidity, consistent with theoretical predictions (e.g., Bhide (1993)).
The full paper is available for download here.
