Institutional Blockholders Research Articles

Corporate Governance and the Cost of Capital: Evidence from Australian Companies

The authors examine a sample of large Australian companies over a 10‐year period with the aim of analyzing the role that firm‐level corporate governance mechanisms such as insider ownership and independent boards play in explaining a company's cost of capital. The Australian corporate system offers a unique environment for assessing the impact of corporate governance mechanisms. Australian companies have board structures and mechanisms that are similar in design to Anglo‐Saxon boards while offering a striking contrast to those of German and Japanese boards. At the same time, however, the Australian market for corporate control is much less active as a corrective mechanism against management entrenchment than its U.S. and U.K. counterparts, making the role of internal governance mechanisms potentially more important in Australia than elsewhere.The authors report that greater insider ownership, the presence of institutional blockholders, and independent boards are all associated with reductions in the perceived risk of a firm, thereby leading investors to demand lower rates of return on capital. In so doing, the study provides evidence of the important role of corporate governance in increasing corporate values.

Family control, multiple institutional block-holders, and informed trading

This paper investigates how large family shareholders and institutional block-holders jointly influence informed trading and firm valuation in the Hong Kong stock market. It combines market microstructure research with studies on the governance roles of multiple block-holders and finds that institutional block-holders rely on their relative controlling power vis-à-vis family owners to mitigate problems associated with informed trading. They also use their ownership rights to improve the structure of informed trading. However, these governance roles are predominantly exercised by pressure-resistant institutional block-holders. Informed trading reduces firm valuation, while an improvement in its structure increases valuation. Therefore, the governance roles of controlling families and pressure-resistant institutional block-holders may have different implications in terms of investors’ perceptions of private information risk.

The Role of Banks in Dividend Policy

We use loan‐specific data to document a significant inverse relation between a firm's dividend payouts and the intensity of a firm's reliance on bank loan financing. Banks limit dividend payouts to protect the integrity of their senior claims on the firm's assets. Moreover, dividend payouts decline in the presence of monitoring by relationship banks, which acts as an effective governance mechanism, thereby reducing the gains from precommitting to costly dividend payouts. Bank monitoring and corporate governance (insider stake and institutional block holdings) are complementary mechanisms to resolve firm agency problems, both reducing the firm's reliance on dividend policy.

Blank Check Acquisitions

Special Purpose Acquisition Companies (SPACs), a particular type of blank check firms, have risen dramatically since 2003 and account for one third of the U.S. IPO market in 2008. Compared to other public acquirers, SPACs tend to make focused acquisitions, target mostly private companies, are less likely to do cash only deals or tender offers, and less likely to complete acquisitions. SPACs exhibit a mean cumulative abnormal return of 1.7% upon deal announcement and a monthly excess return of 1.5% from deal announcement until closing. I show that SPACs make better acquisitions: they negotiate an additional 7.6% discount compared to other public acquirers that bid for private targets. The results highlight the role of specialization, ownership structure, and independent long-term institutional blockholders’ monitoring as important corporate governance mechanisms in SPACs.

Information Externalities in Corporate Governance

This paper studies the interactions between monitoring choices in different firms. Shareholders gather information about a common industry shock and subsequently intervene with management. An information externality arises because intervention transmits information about industry conditions to shareholders in competing firms. Closer monitoring in one firm improves the performance of industry peers. In equilibrium, all firms free-ride and there is underprovision of monitoring. A regulatory cap on CEO compensation can increase investor welfare. Disclosure of shareholder intervention is socially valuable and inefficiently low in equilibrium. Using U.S. data on forced CEO turnover, I provide empirical evidence of information spillovers across firms. Controlling for various performance measures, I find that CEOs who perform intermediately are significantly more likely to be dismissed after other CEOs in their industry have been fired. At the same time, CEOs’ turnover risk is not related to firings outside of their industry. The predictive power of peer decisions for turnover risk is significantly stronger for firms with low institutional blockholder ownership.

Institutional Investors, Monitoring, and the Transformation of Underperforming Firms

We focus on chronically underperforming firms and assess the roles of institutional investors in either facilitating asset redeployment or entrenching managers. We find that, in aggregate, institutions exhibit a flight to quality, selling shares in firms that subsequently fail. For underperforming firms that survive, institutional holdings are associated with improved performance, but abnormal returns are still negative and return on assets and Tobin’s Q are still low. Our evidence suggests that many of the findings in previous research of positive relationships between institutional holdings and abnormal returns, return on assets, and Tobin’s Q may be entirely explained by flight to quality combined with the distressed firm anomaly. We find no evidence that holdings of traditional activist public pension funds lead to improved performance. Nor do performance results support positive roles for institutions with long-term holdings. However, activist hedge funds are different in that they significantly increase holdings in firms that are subsequently acquired. Also, short-term holdings by institutions are associated with positive subsequent performance. Results for institutional blockholders are mixed, reflecting their heterogeneity. The distinction between independent and non-independent (gray) institutions does not appear to matter. We contrast the results to those for consistently overperforming firms; the analysis points to a more limited governance role of institutions for firms that are performing well.

Institutional block-holdings of UK firms: do corporate governance mechanisms matter?

Using a sample of UK firms, we find that institutional block-holding is negatively associated with directors’ ownership and is positively associated with board composition, suggesting that institutional block-holders regard directors’ ownership and board composition as substitute and complementary control mechanisms, respectively. We also show that UK institutional block-holders prefer smaller firms and firms with a shorter listing history. The presence of institutional block-holders is associated with smaller boards and lower trading liquidity. Finally, our results indicate that the investment preference of UK institutional block-holders varies with the level of their shareholding.

The adoption of supermajority-independent boards in the post-Enron era

Combining insights from the agency theory and sociopolitical perspectives, this study examines the extent to which factors such as ownership structure, CEO power, and firm performance influence firms’ adoption of board independent reform advocated by shareholder activists. Event history analysis using extensive data on 1083 Standard & Poor’s 1500 companies from January 2002 to December 2004 shows that firms with more powerful CEO were less likely to adopt supermajority-independent boards, while both poorly performing firms and large firms were more likely to adopt such board structure. We also find that higher institutional blockholder ownership increased the likelihood of the adoption in firms managed by less powerful CEOs, while external non-institutional blockholder ownership decreased the likelihood of the adoption.

A Comparison Between One‐Tier and Two‐Tier Board Structures in France

AbstractFrench companies operate in a unique environment characterized by the strong involvement of block shareholders such as families and banks. Furthermore, the French legal system allows firms to choose between a one‐tier or a two‐tier board structure. This study investigates whether this choice can affect the firm's operating and stock performance. Our regression results provide strong evidence that ownership and board structures are used together as corporate governance tools. In particular, the agency cost of debt is strongly affected by their interaction when institutional investors are also bank lenders. Our test results show that while family control has a negative impact on corporate governance, French institutional blockholders play a positive role as monitors of one‐tier structures. In contrast, they are more likely to misuse the two‐tier board system by promoting interlocked directorship, board opacity and their own interests as creditors. Our regression analysis reveals that foreign institutional investors do not have any impact on firm performance, regardless of board structure. Finally, we do not find any inverse relationship between board size and efficiency in France.

Governance Through Trading: Evidence from Trading Activity Around Earnings Announcements

Recent theories argue for governance through trading, which I call grading, as an alternative governance mechanism to direct intervention (voice). Grading is the mechanism in which higher trading impounds new information into the price, pushing it toward its fundamental value, thus inducing higher managerial effort ex-ante. I study abnormal trading reactions to earnings announcements under various conditions to understand the extend to which grading complements voice. Similar to voice, grading is driven by institutional as supposed to individual trading behavior. However, I show that grading nicely complements voice under various conditions. First, when a multiple blockholders structure reduces the effectiveness of voice due to the free rider problem, grading is strengthened. Second, grading is stronger when the largest institutional blockholder is a priori non-interventionist as supposed to interventionist. Last, contrary to the fact that liquidity impairs voice by reducing the cost of exit, grading strengthens with liquidity.

Creditor Control of Free Cash Flow

With free cash flows, borrowers can accumulate cash or voluntarily pay down debts. However, sometimes creditors impose a mandatory repayment covenant called “excess cash flow sweep” in loan contracts to force borrowers to repay debts ahead of schedule. About 17% of borrowers in our sample (1995-2006) have this covenant attached to at least one of their loans. We find that the sweep covenant is more likely to be imposed on borrowers with higher leverage (i.e., where risk shifting by equity holders is more likely). The results are robust to including borrower fixed effects or using industry median leverage as a proxy. The covenant is more common also in borrowers where equity holders appear to have firmer control, e.g., when more shares are controlled by institutional block holders, when firms are incorporated in states with laws more favorable to hostile takeovers, or when equity holders place higher valuation on excess cash holdings. These determinants suggest that the sweep covenant may be motivated by creditor-shareholder conflicts. Finally, we show that the covenant has real effects: borrowers affected by the sweep covenant indeed repay more debts using excess cash flows, and they spend less in capital investment and pay out fewer dividends to shareholders.

The Role of Banks in Dividend Policy

We document a significant inverse relationship between a firm’sdividend payouts and reliance on bank loan financing. Banks limitdividend payouts to shareholders in order to protect the integrity oftheir senior claims on the firm’s assets. Moreover, dividendpayouts decline in the presence of monitoring by relationship banks,which acts as an effective governance mechanism, thereby reducing thegains from pre-committing to costly dividend payouts. Bank monitoringand corporate governance (insider stake and institutional blockholdings) are complementary mechanisms to resolve firm agency problems,both reducing the firm’s reliance on dividend policy.

Characteristics of institutional investors and discretionary accruals

PurposeThe purpose of this paper is to examine the differential effects of institutional non‐blockholders (NONB) and active institutional blockholders (ACTB) on earnings management behavior, as measured by discretionary accruals.Design/methodology/approachThis paper also proposes that the hypothesized influence of NONB and ACTB on earnings management behavior is affected by earnings pressure (EP) (i.e. the gap between target earnings and pre‐managed earnings). In particular, it believes that the stimulating effect of NONB on earnings management may not manifest when the stimulating effect of EPs is already strong and the mitigating effect of ACTB may manifest only when the stimulating effect of EP is there. The sample into three EP conditions: pressure to increase earnings, neutral pressure and pressure to decrease earnings is grouped. Consistent with the expectations, the paper finds that NONB stimulates earnings management, but only when EP is not strong and that ACTB mitigates earnings management, but only when there is pressure to increase earnings.FindingsThis paper also predicts that ACTB will need to exercise their monitoring power only when EP is strong. The results confirm this prediction, but only when there is strong pressure to increase earnings. When there is strong pressure to decrease earnings, inconclusive evidence regarding the effect of ACTB is found. This may imply that ACTB are conservative since they appear to be more likely to limit income‐increasing accruals than they are to limit income‐decreasing accruals.Originality/valueThis paper's contributions to the literature are twofold: the paper shows that the characteristics of institutional investors (INSTs) should be considered when examining the relationship between INSTs and earnings management; the paper shows that the direction and level of EP should be considered when evaluating the relationship between INSTs and earnings management.

Executive Compensation Disclosure and Private Control Benefits: A Comparison of U.S. And Canadian Dual Class Firms

Prior research on the cross-country variation of accounting choices induced by managerial incentives to extract private benefits is limited in its use of accounting measures that have limited empirical correlations with direct estimates of private control benefits. This study attempts to resolve the void in the literature by using a measure of compensation disclosure that is directly correlated with excess compensation - one form of private control benefits. The evidence shows that compensation disclosure choices induced by separating control rights from cash flow rights in dual class firms is stronger in a weaker investor protection environment. This is contrary to prior research which has documented a weaker relation in weaker investor protection environments. The evidence in this study is consistent with the explanation that a weaker investor protection environment magnifies the agency costs of dual class equity inducing firms to increase disclosure in an attempt to mitigate these increased agency costs. Based on prior literature, Canada and the U.S. are used to proxy for weak and strong investor protection environments respectively. This study also sheds light on the role of institutional investors in influencing executive compensation disclosure. The presence of an institutional blockholder greatly enhances the quality of executive compensation disclosure.

The Medium of Exchange, Control Loss and Wealth Effect on Suppliers in Mergers and Acquisitions

I examine the corporate control implications of the financing decision in mergers for bidder suppliers. Specifically, I hypothesize that reallocation of control rights from bidder management to target management and block-holders through stock financing in mergers, especially non-diversifying ones, has negative value implications for bidder suppliers due to the nature of incomplete contracting. Because future contingencies are hard to predict, intense trading relationships between the bidder and its suppliers are often governed by implicit agreements. Since the ability of management to deliver on implicit agreements with suppliers is closely related to their controlling power, corporate decisions that dilute managerial power such as stock financing in M&A transactions will have an adverse impact on the firm's suppliers. To the extent that bidder suppliers cannot influence the choice of target, the target ownership structure and the medium of exchange in mergers, the financing decision of bidder would constitute an exogenous shock to bidder suppliers, and provides an ideal setting to examine value implications on bidder suppliers of corporate control changes in the bidder. In support, I find that bidder suppliers affected by non-diversifying mergers suffer strong negative announcement returns of -1.04% in stock offers, but not in cash offers. Moreover, the announcement returns of bidder suppliers become more negative with larger control rights transfer to target management and institutional block-holders in stock offers. Bidder suppliers, however, can rely on higher percentage of sales to the bidder to mitigate the adverse impact of stock financing. In contrast, these effects are not observed for bidder suppliers affected by stock financing under diversifying mergers. These findings remain robust to controlling for the use of over-valued equity using the bidder's accruals and run-up in stock price. Furthermore, bidder suppliers face lower retention likelihood, albeit weakly, when stock financing is used over cash financing under circumstances where there is control rights transfer to target block-holders. Lastly, under non-diversifying mergers, bidder suppliers affected by stock financing and are dismissed experience worse performance post-merger.

Corporate Governance and the Hedging Premium Around the World

This paper examines the use of foreign currency derivatives (FCDs) as a proxy for risk management and its potential impact on firm value in a broad sample of firms from thirty-nine countries between 1990 and 1999. Our sample allows us to exploit differences in corporate governance across firms and countries, their impact on risk management policies and their value implications. We find that on average, hedging is associated with higher firm value around the world and that corporate governance is an important factor in assessing the value of risk management. The hedging premium is statistically significant and economically large for firms with strong internal corporate governance (such as those with an institutional blockholder) and those which reside in countries with strong external governance (such as those with an English legal origin), and insignificant for firms with weak internal governance and those which reside in countries with weak external governance. Finally, hedging is (not) valuable even when internal corporate governance is weak (strong), if the firm happens to reside in a country with strong (weak) external governance. Overall, our findings suggest that both firm-level and country-level corporate governance play a significant role in understanding when risk management is associated with higher value. Moreover, our results imply that risk management is one channel through which stronger corporate governance translates into higher firm value.

The Impact of Shareholder Control on Bondholders

This paper investigates the effect of shareholder control on bondholder wealth. While stronger shareholder control can benefit bondholders by disciplining managers, it also increases the likelihood of events that can hurt bondholders, e.g. hostile takeovers. We hypothesize that shareholder control can have contrasting effects on bond yields depending on the takeover vulnerability of a firm. Using the presence of an institutional blockholder to proxy for shareholder control and firm-level anti-takeover provisions to proxy for takeover vulnerability, we find that shareholder control is associated with lower yields if the firm is protected from takeovers. We also find that shareholder control is associated with higher yields if the firm is exposed to takeovers. The contrasting effects of shareholder control on yields are the strongest for firms that are small and have low leverage. In the presence of shareholder control, the difference in bond yields due to differences in takeover vulnerability can be as high as 93 basis points. Further, the results are insignificant for a sub-sample of firms where the bondholders are protected from takeovers through the poison put covenant. Bond ratings also appear to incorporate a similar effect of shareholder control on bondholders Finally, we find that a bond pricing model that does not account for shareholder control generates an annualized abnormal return of 1% to 1.4% for portfolios that long firms with both strong shareholder control and high takeover vulnerability and short firms without either shareholder control or takeover vulnerability. Combined, these results suggest that the use of different governance mechanisms, such as shareholder monitoring and takeover vulnerability, depends on a firm s capital structure and that bond-pricing models should account for shareholder control.

Ownership Structure and Stock Market Returns

Ownership structure matters for stock market returns. Based on a dataset of 1,565 small, medium and large sized European firms, over the period 1993-2006 family firms generate higher returns than non-family firms. Abnormal returns are statistically and economically significant. These results are robust to various specifications and hold after adjusting for industry average returns. However, the differences in performance do not seem to be completely explained by Fama and French factors model. In countries with stronger minority shareholders protection, family firms have, on average, lower returns than in countries with weak minority shareholders protection. Finally, over the period 1993-2006 the presence of an institutional blockholder in the ownership structure negatively impacts firms’ stock returns.

How Preussag Became TUI: A Clinical Study of Institutional Blockholders and Restructuring in Europe

Between 1997 and 2004, Preussag, a diversified German conglomerate of “old economy” businesses, transformed itself into TUI, a company focused almost entirely on tourism and logistics. We analyze how Preussag executed this change, and how the change contributed to Preussag's underperformance in the stock market. We find that only the divestitures created value, that the strategy to invest in tourism destroyed value, and that the acquisition premiums Preussag paid were mostly unjustified. The case shows how divestiture programs increase the liquid resources available to management and casts doubt on the positive governance role of institutional blockholders.

Corporate Governance, Cost of Capital and Performance: Evidence from Australian Firms

Using a sample of large Australian firms from 1994 to 2003, we show that variation in firm-level corporate governance mechanisms plays an important role in explaining a firm's cost of capital. Our empirical results show that greater insider ownership, the presence of institutional blockholders and independent boards all serve to reduce the perceived risk of a firm, thereby leading investors to demand lower rates of return on capital provided. This highlights the important role that corporate governance plays in creating value for shareholders by reducing the cost of external financing. Given the inconclusiveness of existing literature that uses Q to measure firm value, this research provides an alternative and potentially more suitable way to investigate the impact of corporate governance on firm value.