Ownership Dynamics with Large Shareholders

The following post comes to us from Marcelo Donelli and Borja Larrain, both of the Universidad Catolica de Chile, and Francisco Urzua of the Department of Finance at Tilburg University.

In our paper Ownership Dynamics with Large Shareholders: an Empirical Analysis, forthcoming in the Journal of Financial and Quantitative Analysis, we study ownership dynamics in a country where controlling shareholders are prevalent. We find that ownership structures are very persistent and that pyramidal structures are associated with less dispersion than other control structures. We also find that dilution is preceded by higher returns and predicts low returns in the future, which is a typical feature of market timing.

It is an established fact that ownership is typically dispersed in the US and the UK, but concentrated in the rest of the world. Yet, why is it that markets do not converge to the dispersed ownership paradigm of the US/UK? Why is it that approximately 20% of firms in the US and UK are tightly controlled, whereas 70% of firms in Continental Europe are tightly controlled? What prevents controlling shareholders from diluting their stakes in the firms they control? We aim to provide an answer to these questions by examining Chilean firms’ ownership dynamics in a 20 year period (1990-2009). We benefit from Chile’s unique features, such as improvements in the protection to minority shareholders, economy’s steep growth (per capita GDP more than doubled in PPP terms), markets’ booms and busts, and excellent data sources. Despite these unique features, what we learn sheds light on ownership dynamics in a number of different markets, as Chile is similar to other developed and emerging economies in terms of financial development, the overall level of ownership concentration, and protection to minority shareholders.

The results show that there is no trend towards dispersion in spite of all the significant macroeconomic changes Chile went through in the last 20 years. For example, the median controller holds 61% of shares in 1990 and 67% in 2009, while less than 1% of firms are widely held when applying the threshold of 10% of ownership usually considered in the literature. Despite this stability, significant changes in ownership are not uncommon. In a typical year, approximately 6% of controllers reduce their stake by 5% or more, while 7% increase their stake by a similar amount. Less than 10% of these events correspond to changes in the identity of the controller, most being accompanied with changes in the board of directors. These changes may have a strategic purpose such as sealing an alliance with another family or a financing partner.

Dilution is less likely when pyramidal structures produce a wedge between the controller’s voting and cash-flow rights. Outside investors might be reluctant to buy shares when there is a wedge because the controller’s interests are poorly aligned with those of minority investors. At the same time, controlling shareholders could be less willing to sell a stake in companies with a wedge as investment can be easily funded with capital from other firms in the pyramid. Given how common pyramids are throughout the world, our results shed some light on ownership structures in a wide variety of countries. We also find that stock market variables are important. Ownership dispersion is preceded by high stock returns and predicts low stock returns in the future, a typical feature of market timing. This is particularly the case for dilution through share issuance, as opposed to a block sale. Therefore, controlling shareholders may be exploiting inside information at the expense of naïve or less-informed outside investors.

The policy implications about concentrated ownership are not clear cut. Large shareholders have better incentives to get involved in firms, although they may also become entrenched. It is not obvious that ownership dilution per se has to be a policy objective for stock market regulators. However, in the case that dilution becomes a policy objective, it is worth noting that any law aiming to promote ownership dilution should consider that what matters seems to be how firms are controlled rather than the legal environment as a whole.

The full paper is available for download here.

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