Corporate Governance: Key Points on Shareholder Ownership

Defining Ownership and Control

  • Ownership: Refers to ownership of cash flow rights.
    • Cash flow rights give the holder a pro-rata right to the firm’s earnings as long as the firm is a going concern.
    • They also provide a pro-rata right to the firm's assets upon liquidation.
  • Control: Refers to ownership of control/voting rights.
    • Control rights allow the holder the right to vote on certain agenda points at shareholders' meetings, such as appointment or dismissal of board members.

Shareholder Ownership

  • Shareholders can influence management actions.
  • In typical US and UK corporations, most individuals own very small shares, resulting in limited incentives to monitor management closely.
  • In many other countries, large shareholders have significant control over firms.

Dispersed vs. Concentrated Ownership

  • Dispersed Ownership:

    • Advantages:
    • Increased liquidity leads to a lower cost of capital.
    • Vulnerability to hostile takeovers provides pressure on managers to perform.
    • Disadvantage:
    • Free-riding occurs as shareholders avoid monitoring management as they share benefits with little personal cost.

  • Concentrated Ownership:

    • Advantage:
    • Power and incentives for a few shareholders lead to better management oversight.
    • Disadvantage:
    • Risks of expropriation of minority shareholders exist.

Combinations of Ownership and Control

  • Combination A: Dispersed ownership and weak control.

    • Characteristic of most UK & US firms.
    • Advantages: Liquidity and an active market for corporate control.
    • Disadvantages: Insufficient monitoring; main conflict is between management and shareholders.
    • Example: Coca Cola Company, where large shareholders own minor percentages leading to diluted control.

  • Combination B: Dispersed ownership and strong control.

    • Common in non-US/UK firms.
    • Advantages: High monitoring incentives and an active equity market.
    • Disadvantages: Risk of minority shareholder expropriation; main conflict is between controlling and minority shareholders.
    • Possible mechanisms that create a wedge between ownership and control include deviations from the one-share-one-vote principle, pyramid ownership structures, dual-class share structures, and proxy votes.

  • Combination C: Concentrated ownership and weak control.

    • Rarely found, applies to some firms with voting caps.
    • Advantages: Protection for minority rights.
    • Disadvantages: Poor monitoring and low liquidity; conflict primarily between management and shareholders.
    • Example: Nestlé SA has a voting cap limiting any individual's voting power to 5%.

  • Combination D: Concentrated ownership and strong control.

    • Advantages: High incentives for monitoring.
    • Disadvantages: Low liquidity and lesser takeover opportunities; conflict between controlling shareholders and minorities.
    • Example: Audi AG was delisted after Volkswagen AG squeezed out minority shareholders.

Corporate Control Worldwide

  • 2012 Findings: Control of firms varies, highest in civil-law countries; shareholder protection rights correlate with dispersed ownership.
  • Majority shareholders are most common in Europe and lower in the US/UK.
  • Large Shareholder Dynamics:
    • Ownership structures also differ by region - family control is significant in Western Europe; institutional investors dominate in the UK.

Benefits and Costs of Large Shareholders

  • Benefits:

    • They can effectively monitor management, mitigating free-rider issues.
    • Their influence can lead to reduced agency costs and increased firm value.

  • Costs:

    • Large shareholders may prioritize their interests over minority shareholders.
    • Through control rights, they can extract private benefits at the expense of others.

The Relationship Between Large Shareholders and Firm Value

  • Two Dominant Hypotheses:
    1. Monitoring Hypothesis: Concentrated ownership correlates positively with firm performance due to improved oversight.
    2. Expropriation Hypothesis: Concentrated ownership leads to negative outcomes due to potential conflicts between large and minority shareholders.
  • Findings from Spanish firms indicate:
    • At low levels of ownership concentration, firm value increases.
    • At high levels, negative consequences emerge due to potential expropriation.

Summary

  • Shareholder influence on management is significant, with ownership structures varying widely across markets. Ownership can be either dispersed or concentrated, influencing both the power dynamics within a firm and the potential for value creation or conflict among shareholders.

Suggested Readings

  • Goergen, M. (2018) "Corporate Governance: A Global Perspective”, Cengage Learning EMEA.
  • Various research papers analyzing ownership structures and firm values across different geographical contexts.