Print
E-MailClifford G. Holderness is Professor of Finance at the Carroll School of Management at Boston College. This post is based on a forthcoming article by Professor Holderness. Related research from the Program on Corporate Governance includes The “Antidirector Rights Index” Revisited by Holger Spamann.
One of the most influential findings from the law and finance literature is that large-percentage shareholders in public corporations are a response to weak legal protections for public market investors. This theory was initially proposed in La Porta, Lopez-de-Silanes, Shleifer, and Vishny (1998) and has been confirmed and refined by the same researchers and others. The theory serves as a cornerstone for many analyses and recommendations in corporate governance. The belief is that when legal protections for public market investors are weak, stock ownership will be concentrated.
In Law and Ownership Reexamined I reexamine the relation between investors’ legal protections and ownership concentration and find no evidence of any relationship, either negative or positive. Although ownership concentration varies widely both within and across countries, there is no evidence that these differences reflect legal differences.
My paper differs from earlier research in that I use firm observations and the most accurate, representative ownership data available. Earlier research, in contrast, used country averages of ownership concentration. This means that researchers were unable to control for the influence of firm-level characteristics on ownership concentration (such as firm size); individual firms were weighted differently (sometimes by a factor of 1,000 or more) depending on the composition of the database used; and a misleading impression of artificial clustering was created by eliminating all within-country variation in ownership concentration. (These problems are explained in a companion article which is also summarized in this forum here.) Earlier research also used electronic data, which is widely seen as inaccurate, or small hand-collected samples, which although accurate may not be representative of other firms in the same country.
I conduct a wide range of empirical investigations both with and without firm-level controls and find no support for any relation, negative or positive, between investors’ legal protections and the ownership concentration of public corporations. In cross-sectional analyses of corporations from 32 countries, about half of the legal measures proposed in the literature as mattering to investors are positively related to ownership concentration and about half are negatively related. Most measures, including all of the most commonly used measures such as the Anti-Director Rights Index and a country’s legal origins, are statistically insignificant; those few that are (weakly) significant in the baseline analyses lose any significance in robustness tests.
The existing evidence on long-run changes of legal protections and ownership within a diverse group of countries, which is summarized for the first time in this paper, likewise fails to support the hypothesized relation. Several countries strengthened investor protection laws over the years studied, but none experienced the predicted decline in ownership concentration. Instead, as investor protection laws grew stronger, in most of these countries ownership became more concentrated.
Finally, the two theories behind the proposed negative relation of law and ownership are inconsistent with each other and inconsistent with established empirical regularities. One branch of the theoretical literature views large shareholders as outsiders who monitor managers to halt the appropriation of corporate resources by insiders. Under this theory, when shareholders have few rights to sue managers, the value of a blockholder who can monitor managers increases and so does ownership concentration. A problem with this theory is that around the world most large shareholders are managers not outside monitors. There is little reason to expect blockholders to monitor themselves. Monitoring implies an external constraint.
The other branch of the theoretical literature views large shareholders as insiders who appropriate corporate resources. Under this diametrically opposed view of blockholders, the frequency of blockholders increases as legal constraints decline because it becomes easier for large shareholders to appropriate corporate resources. Although this theory is consistent with the empirical regularity that most blockholders are insiders and thus in a position to appropriate corporate resources, a problem is that existing evidence suggests that in most countries firm value does not decrease with ownership concentration and may even increase.
In short, although the proposition that ownership concentration of public corporations is inversely related to investors’ legal protections is widely held and influential, neither the empirical evidence nor the theory is supportive.
