Does Management Ownership Have Negative Consequences? Evidence from a Natural Experiment

Abstract

This paper documents a new cost of insider ownership; we call this the minority-alignment cost. This cost arises when higher insider ownership incentivizes the insider to act in the best interest of a minority of shareholders. These actions thus hurt the interests of the majority of shareholders and therefore firm value. We document evidence consistent with this cost of insider ownership using a natural experiment caused by the 2012 presidential election and the impending fiscal cliff. In this setting, insiders (who are subject to dividend taxes) had a personal incentive to pay out large special dividends, and this incentive was stronger for insiders who owned a larger fraction of the firm. We show that when insider ownership was high, firms were less responsive to the tax incentives of the investor base (i.e., the fraction of taxable vs. non-taxable shareholders). Further, when there was more misalignment (high insider ownership combined with high ownership by non-taxable investors), these decisions had worse valuation implications and often destroyed firm value.