Do Ownership and Control Affect Firm Value?

The following post comes to us from Bang Dang Nguyen of Judge Business School at the University of Cambridge and Kasper Meisner Nielsen of the Department of Finance at Hong Kong University of Science & Technology.

In our paper, When Blockholders Leave Feet First: Do Ownership and Control Affect Firm Value?, which was recently made publicly available on SSRN, we investigate the effect of ownership and control on firm value, a longstanding question in finance, by employing the sudden death of large individual shareholders as a natural experiment. Our analysis focuses on stock price reactions to the deaths of individual blockholders who hold 5% or more in a U.S. listed firm. The main advantage of this approach is that sudden deaths are exogenous events that allow us to identify the impact of ownership and control on firm value. We analyze the value of inside and outside blockholders. Outside blockholders differ from insiders in that they are not actively involved in day-to-day management. We compare the magnitude of stock price reactions between inside and outside blockholders and note that any effect of ownership transition on firm value due to liquidity or anticipated takeover activity is likely to cancel out. The difference in the stock price reactions between inside and outside blockholders is therefore informative about the value of ownership and control.

Our study is the first to evaluate the effect of blockholders on firm value through the use of sudden deaths. In a related paper Slovin and Sushka (1993) analyze the event of death of blockholders. We draw a distinction between sudden and non-sudden deaths because entrenched blockholders are likely to hold onto their ownership until their deaths. Our concerns about entrenchment appears to be relevant as our findings show that stock price reactions are systematically more positive for non-sudden deaths than for sudden deaths. Using sudden death as opposed to non-sudden death is thus important for the interpretation of the effect of blockholders on firm value.

We find, first, that the average stock price reaction to the sudden death of inside blockholders ranges from -5% for small ownership stakes to 4% for large ownership stakes. The positive and significant relationship between managerial ownership and stock price reactions, thus, implies that the beneficial effect of managerial owners disappears as ownership increases. Among inside blockholders, the entrenchment effect of concentrated ownership appears to dominate the incentive effect as ownership increases.

Second, we find that stock prices react negatively to the events of sudden deaths of outside blockholders, with magnitudes ranging from 0% for small stakes to -2% for larger stakes. For outside blockholders, ownership is negatively and significantly related to stock price reactions. The monitoring of outside blockholders thus becomes more beneficial as ownership increases.

Third, we use the difference in stock price reactions between inside and outside blockholders to identify the effect of ownership and control on firm value. To address the concern that the difference in stock price reactions between inside and outside blockholders might also reflect differences in the expected ownership transition, we have collected data on the ownership transitions. It turns out that the ownership transitions are fairly similar across the two types: in most cases the new blockholder is neither an executive nor a director. The striking similarity in transition patterns effectively rules out concerns about the possibility that our results are driven by differences in the expected ownership transition. Consistent with the prior results, we find that the beneficial effect of inside blockholders decreases as ownership increases, while the beneficial effect of outside blockholders increases as ownership increases.

Fourth, we find that our results remain consistent and robust after controlling for the presence and ownership of other blockholders, institutional investors, and anticipated control activity following the deaths. We also show that the results are robust to alternative specifications of our tests.

Our study contributes to the existing literature on the impact of ownership structure and block ownership along several lines. Our first contribution is the use of the sudden deaths of blockholders as a natural experiment to identify the impact of inside and outside blockholders on firm value. We, thus, address one of the most challenging issues in the literature, arising from the endogenous nature of the relationship between ownership and firm value. Though the majority of prior papers have carried out extensive empirical tests to verify the causal relationship, the possibility of unobserved characteristics affecting both ownership structure and firm value is hard to rule out. Our natural experiment based on exogenous events adequately addresses this issue.

Second, while prior studies focus mainly on the role of inside blockholders, we study both inside and outside blockholders. We identify the effect of ownership and control on firm value by comparing stock price reactions to inside blockholders to that of outside blockholders while controlling for firm characteristics in a cross-sectional regression. Because ownership concentration declines for both groups, this comparison effectively controls for any effect of liquidity and anticipated control activity on firm value.

Third, our sample results from a close to random draw on the population of listed firms in the U.S. over a long period. Our results are, therefore, externally valid. That is, this near random draw makes generalizing the conclusions to the population of firms with individual blockholders possible.

The full paper is available for download here.



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