During the seventeenth century, companies were owned and managed by the same people. However as economies grew and developed, so did the world of business. Technology became a vital part of business activity, the demand for large amounts of capital was on the increase. This began the initial process to the separation of ownership and control – managers and shareholders were no longer the same individual and the interest of those who control the business was in conflict with the interest of those who owned the business.
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The main of objectives of this paper are two-fold. First, it highlights the large discrepancies among corporate governance environments. Since environments differ so widely, I conclude there is a need for theoretically grounded measures of corporate ownership and control (that is ownership concentration and voting rights). Secondly, the impact of ownership structure on firm performance is empirically analysed for companies listed on the London Stock Exchange. The corporate landscape of the U. K.
is particularly interesting because of its widely held nature and the liquidity of the market for controlling rights and should therefore create an interesting discussion concerning one of the most debated topics: ‘ownership structure and firm performance’. The paper has been sectionalised as follows. Section 2 is the literature review, which has been divided into two sub-sections: (i) the theoretical background and previous empirical studies on ownership structure and firm performance; (ii) the determinants of ownership structure.
A comparative analysis on the institutional features for the UK is then discussed in Section 3. Section 4 details the database, variables and methodology employed in the study. This is followed by the presentation of summary statistics and regression results in Section 5. The main findings and conclusions are then given in Section 6. Since the seminal work of Berle and Means (1932) concerning the divergence of interest between ownership and control, ownership structure and its relation to the firm’s performance has since been examined by many researchers.
According to Demsetz and Lehn (1985), ” Largely publicly traded corporations are frequently characterised as having diffuse ownership structures that effectively separate ownership of residual claims from control of corporate decisions. ‘ In fact, diffuse ownership yields significant power in the hands of managers whose interest do not coincide with the interest of shareholders. Hence, corporate resources are not used for the maximisation of shareholders’ value.
The divergence in interests between the manager and shareholder gives rise to the principal-agent problem (Jensen and Meckling, 1976) and associated costs of monitoring and protection of control rights. Empirical works that have examined the relationship between ownership structure and frim performance have identified two main measures for ownership structure: ownership concentration and managerial ownership.
Early analysis conducted on managerial ownership and the firm’s performance (see Demsetz and Lehn (1985)) reported a linear relationship between managerial ownership and the firm’s performance. Consequently firms with a high managerial ownership should show high market values. Later studies like Morck et al. , (1988); McConnell and Servaes (1990); McConnell and Servaes (1995); and Kole (1995) however showed that there are non -linear forms, which stem from two possible effects: alignment and entrenchment.
At low levels of ownership the manager’s role is to align the interest of the shareholders and managers to increase the firm’s performance but at high levels of equity ownership managers partake in activities which reduce the firm’s value, and at certain levels of ownership they become entrenched and have sufficient control to follow their own objectives with no need to be afraid of disciplinary actions from other ownership interests. The second measure of ownership structure is ownership concentration.
In corporate governance literature several distinct forms of concentration have been identified: large shareholders, takeovers and creditors, but for the purpose of this study emphasis is placed on large shareholders. Having large shareholders is seen as the most direct way to align cash flow and control rights of outside investors. This can mean that one or several investors in the firm would have minority ownership stakes, for example 10 or 20 percent. Concentration of ownership is also used as a complementary approach to corporate governance as discussed by Shleifer and Vishny (1997).
One of their main arguments states ” If legal protection does not give enough control rights to small investors to induce them to part with their money, then perhaps investors can get more effective control rights by being large”. In other words instead of relying on legal protection, shareholders can get more effective control simply by being large. So, in cases where large shareholders are said to own 51 or more percent, large shareholders would have direct control of the firms and their management addressing the agency problem arising from the separation of ownership and control.
The agency problem becomes resolved since both managers and shareholders share the common interest of profit maximisation and shareholders have enough control over the firm’s assets to have their interests respected. On the other hand or in less extreme cases, a substantial minority shareholder can avoid the so-called free rider problem since the incentive to collect information and monitor management can occur. From the model constructed by Shleifer and Vishny (1986), it has been shown that large shareholders influence corporate value.
They suggest that large shareholders, that is banks, pension funds, security companies and families, monitor managers, reduce the premium of takeovers hence increasing the number of possible bidders and the acquisition probability causing the value of the firm to increase. Although, being large is seen as a way to enhance firm value, there are however some drawbacks and costs associated with having large investors (or shareholders). The most obvious of these costs, which is mostly used as an argument for dispersed ownership, is that large investors lack diversification and hence bear numerous risks (see, Demsetz and Lehn (1985)).
However, since concentrated ownership is present in most countries across the world, costs associated with the lack of diversification when compared to costs associate diminishing control is not seen as great a cost for large investors to bear. According to Shleifer and Vishny (1997), ‘ A more fundamental problem is that large investors represent their own interests, which need not coincide with the interests of other investors in the firm, or with the interests of employees and managers.