Shareholder Level Research Articles

Diversification and diffusion: A social networks and institutional perspective

We examine the diffusion of a major firm strategy, unrelated diversifica- tion, among a population of Chinese listed firms during the 1991 to 2002 period. We propose that a firm's social network can serve as both an information disseminator and a channel of influence in the diffusion of the diversification decision. Further, we investigate how the institutional environment alters the role of a network over time. We find that firms are more likely to diversify into conglomerates if (1) they occupy a central position in the network; (2) they have higher levels of government shareholding; and (3) the firms with which they have network ties diversify. Moreover, as the institutional environment strengthens over time, the influence of a firm's network partners decreases. Consistent with these results, we contend that diversification is not only a response to economic and agency concerns, but also a function of the social and institutional context in which a firm is embedded.

Family ownership, board independence and voluntary disclosure: Evidence from Hong Kong

This paper empirically examines the relationship between the extent of voluntary disclosure and levels of family ownership and board independence including the influence of an independent chairman. Using hand-collected data on voluntary disclosure for a sample of 273 listed firms in Hong Kong for the year 2002, the results show that at moderate to low levels of family shareholding (25% or less), the convergence of interest effect is dominant and the extent of voluntary disclosure is relatively low. At higher levels of family shareholding (more than 25%), the entrenchment effect dominates and is associated with higher voluntary disclosure. In addition, the results show that the appointment of an independent chairman is positively associated with the level of voluntary disclosure. Most importantly, the appointment of an independent chairman appears to mitigate the influence of family ownership on voluntary disclosures, and holds for firms with a non-independent chairman. While the extent to which independent non-executive directors are appointed to the board is positively associated with voluntary disclosure, the role of such directors is mitigated by the role of chairman.

Corporate governance in banking: A survey of the literature

The aim of this paper is to explain the particular characteristics of the corporate governance of banks and its role for good bank performance. In order to do that, it reviews the existing literature on this issue trying to answer three main questions: (i) Why are banks different? Existing research points at diverse features, such as, regulation, supervision, capital structure, risk, fiduciary relationships, ownership, and deposit insurance, that would make banks special and thereby influence their corporate governance. (ii) What is different about bank governance? According to past studies, banks’ boards of directors are larger, more independent, have a superior number of committees and meet more often, but seem to play a weaker disciplinary role. Executive compensation would be higher in banking, but pay-performance sensitivity appears lower. (iii) What works for banks? Larger boards, more concentrated ownership structures and certain levels of managerial shareholdings are the principal factors suggested by the empirical evidence to date that seem to lead banks to higher performance.

Ownership structure and the likelihood of financial distress in the Netherlands

This article examines the impact of ownership structure on the likelihood of financial distress of Dutch firms listed on the Amsterdam Stock Exchange (Euronext) from 1992 to 2002. We find that firms with higher levels of managerial shareholdings are less likely to experience financial distress. This finding is consistent with the alignment hypothesis that managers with higher ownership stakes are more likely to avoid financial distress. We also find empirical evidence that large outside shareholders reduce the probability of financial distress. Monitoring incumbent management by large outside shareholders might prevent sub optimal managerial behaviour and reduce the likelihood of financial distress. Finally, we find no evidence that high levels of institutional shareholdings are associated with a lower probability of financial distress.

The impact of bank ownership concentration on impaired loans and capital adequacy

This paper examines the impact of bank ownership concentration on two indicators of bank riskiness, namely banks’ non-performing loans and capital adequacy. Using balance sheet information for around 500 commercial banks from more than 50 countries averaged over 2005–2007, we find that concentrated ownership (proxied by different levels of shareholding) significantly reduces a bank’s non-performing loans ratio, conditional on supervisory control and shareholders protection rights. Furthermore, ownership concentration affects the capital adequacy ratio positively conditional on shareholder protection. At low levels of shareholder protection rights and supervisory control, ownership concentration reduces bank riskiness.

Minimum Shareholding Requirements for Insiders: Evidence from Taiwanese SMEs

ABSTRACTManuscript Type: EmpiricalResearch Question/Issue: This study aims to evaluate the suitability of Taiwan's minimum shareholding requirement for small‐ and medium‐sized enterprises (SMEs), and to examine whether stewardship theory and both incentive and entrenchment effects can characterize the ownership‐performance relationship simultaneously.Research Findings/Results: We apply new empirical methods to a balanced panel dataset including 496 firm‐level observations of 62 Taiwanese SMEs publicly traded from 1999 to 2006. The results show a nonlinear ownership‐performance relationship, first negative then positive, with a single threshold value of insider ownership (5.4 per cent). This indicates that both effects combine and that the current regulated minimum level of insider shareholdings for public SMEs may be too high.Theoretical Implications: Our evidence supports both convergence‐of‐interests and entrenchment effects and suggests a better specification that prevents spurious relations obtained from traditional methods. The stewardship theory does work in Taiwan. Insiders behave as loyal stewards rather than motivated by desire for entrenchment. Our empirical evidence suggests an avenue of future research, specifically to form better strategies for those involved in corporate governance.Practical Implications: We suggest that Taiwanese authorities should lessen ownership obligations, thereby leading to improved corporate governance by increasing the independence of the boards of directors. Emerging markets can learn from the Taiwan experience and then formulate their own regulations. Publicly traded SMEs could offer compensation to insiders such as stock options and performance shares. Asymmetric information problems often experienced by outside stockholders and foreign investors can be alleviated by these signals of insider ownership.

Deferred Shareholder Taxation – Implementing a Neutral Business Tax in the European Union

This paper proposes the replacement of the corporate income tax by shareholder-based capital income taxation. Our proposal would guarantee investment neutrality of taxation and reduced tax compliance costs. The proposal is based on the S-base cash flow tax. Under the S-base tax, transactions within the corporate sector are not taxable and only transactions between shareholders and corporations are subject to tax. In contrast to existing S-base cash flow tax systems, tax deductibility of investments is deferred. Rather, the acquisition costs and capital endowments are compounded at the capital market rate and are set off against future capital gains. Dividends and withdrawals are fully taxable at the shareholder level. Because of the deferral of the tax payments our proposal is called ‘Deferred Shareholder Tax’ (DST). The DST exhibits the same neutrality properties as the traditional cash flow tax. Moreover, the compounded inter-temporal credit method ensures that it is neutral with respect to the decision between domestic and foreign investment. To increase acceptance of the DST, current taxpayers’ documentation requirements will be reduced rather than extended. Our proposal could be realised in a single EU country or in all member states of the EU.

Does Corporate Governance Matter? New Evidence from the United Kingdom

Using a governance index derived explicitly from the main recommendations of the London Stock Exchange Combined Code, we find that stronger and more explicit corporate governance systems are associated with increased firm value and performance, as well as lower levels of capital expenditure and institutional shareholdings. While overall corporate governance is important, not all governance characteristics of the firm have the same effect. Whereas ownership and remuneration policies improve corporate performance, the quality of disclosure and audit is a more important driver of corporate value and capital expenditure. Board structure, which is the most frequent topic of research in corporate governance, is shown to have no impact on performance, value, investment or institutional ownership.

Allowance for Shareholder Equity - Implementing a Neutral Corporate Income Tax in the European Union

This paper proposes the introduction of a consumption-based corporate income tax in the European Union. Our proposal would guarantee neutrality regarding investment decisions and at the same time increase cost- efficiency. The proposal is based on the S-base cash flow tax, where transactions within the corporate sector are not at all taxable and only transactions between shareholders and corporations are subject to tax. In contrast to existing S-base cash flow tax systems, tax deductibility of investments is deferred. Rather, the acquisition costs and capital endowments are compounded at the capital market rate and are set off against future capital gains. Dividends and withdrawals are fully taxable at the shareholder level. Because of the similarities to the Allowance for Corporate Equity (ACE) tax our proposal is called Allowance for Shareholder Equity (ASE tax). The ASE tax exhibits the same neutrality properties as the traditional cash flow tax. Moreover, the compounded inter-temporal credit method ensures that it is neutral with respect to the decision between domestic and foreign investment. To increase acceptance of the ASE tax, current taxpayers' documentation requirements will be reduced rather than extended. Our proposal is shaped in a way that it could be realized in a single EU country or in all member states of the EU.

The Impact of Personal and Corporate Taxation on Capital Structure Choices

This paper empirically analyses whether both personal and corporate taxation have an impact on companies' capital structure decisions. We investigate the effect of the difference in taxation of debt and equity financing on capital structures. Our empirical results, based on a comprehensive panel of European firm-level data, suggest that a higher tax benefit of debt has the expected significant positive impact on a company's financial leverage. Particularly, we find evidence that the capital structures of smaller companies respond more heavily to changes in the tax benefit of debt. Additional analysis confirms that not only corporate taxes are relevant for corporate financial planning, but variation in capital income tax rates at the shareholder level implicates significant capital structure adjustments as well. Moreover, we find substitutive relationships between non-debt tax shields and the effect of the corporate tax rate on capital structures.

The Impact of Personal and Corporate Taxation on Capital Structure Choices

This paper empirically analyses whether both personal and corporate taxation have an impact on companies' capital structure decisions. We investigate the effect of the difference in taxation of debt and equity financing on capital structures. Our empirical results, based on a comprehensive panel of European firm-level data, suggest that a higher tax benefit of debt has the expected significant positive impact on a company's financial leverage. Particularly, we find evidence that the capital structures of smaller companies respond more heavily to changes in the tax benefit of debt. Additional analysis confirms that not only corporate taxes are relevant for corporate financial planning, but variation in capital income tax rates at the shareholder level implicates significant capital structure adjustments as well. Moreover, we find substitutive relationships between non-debt tax shields and the effect of the corporate tax rate on capital structures.

Taxation of shareholder capital gains and the choice of payment method in takeovers

From December 1999, shareholders who disposed of shares in Australian takeovers in exchange for scrip could elect to defer capital gains taxation until the disposal of the shares received. We investigate payment method choice by acquiring firms before and after this regulatory change to assess whether target shareholder capital gains tax liabilities became an important factor considered in choosing the form of payment. The results show that, subsequent to the regulatory change, there is a significantly higher probability that equity will be offered as consideration where target shareholder capital gains are greater. This finding confirms the importance of shareholder level taxation in explaining corporate acquisition structure and adds to previous European and US evidence on factors associated with payment method choice in takeovers.

Evaluating the Shareholder Primacy Theory: Evidence from a Survey of Australian Directors

An important debate in corporate governance concerns the validity of the shareholder primacy theory, a theory which depicts the role of company directors as primarily being to act in the interests of shareholders and maximize the wealth of shareholders. This paper reports the results of a survey of company directors that had, among its objectives, testing the validity of the shareholder primacy theory. The authors present the survey findings on four questions: 1. whether directors prioritize the interests of shareholders above the interests of employees and other stakeholders; 2. whether, if that is the case, the source of that prioritisation lies in legal obligation or duty; 3. whether directors in types of companies corresponding to the market/outsider model are more inclined to prioritize shareholder interests (the authors test two models derived from the work of others - the market/outsider model and the insider/relational model where the market/outsider model is based upon indicators such as the company being listed and higher levels of shareholdings by institutional investors); and 4. whether the prioritisation of shareholder interests tends to come at the expense of employees. The key conclusions of the authors include: 1. The shareholder primacy view of directors' priorities has considerable cogency but the results of the survey indicate that this cannot be reduced to a simple proposition that directors will necessarily pursue shareholders' interests at the expense of other stakeholders. There is very little evidence, for example, that directors see short term returns to shareholders through share price or other short term gains as a priority. Clearly, though, shareholders are seen as important and, probably, the most important, of stakeholders. 2. How this prioritisation plays out in directors' minds, however, is far from clear cut. It evidently does not follow that other stakeholders are not prioritised or that their interests are not attended to or seen as legitimate. Other evidence derived from the survey results indicates that employees, for example, are also ranked highly in these respects and sometimes ranked more highly than shareholders. 3. Whatever the normative strength of the shareholder primacy view, shareholder primacy is not derived from a legal obligation on the part of directors, nor is it derived from a view by directors that they are under an obligation to pursue such a policy. Directors indicate that they are legally free to pursue any strategy which they feel will benefit all stakeholders.

Price reaction to rights issues in the Indian capital market

This study examines securities price reaction to announcements of rights issues by listed Indian firms during the period 1997–2005. We document a positive but statistically insignificant price reaction to such announcements. The price reaction is significantly more negative for firms with a family group affiliation compared to firms with no family group affiliation. The notable differential price reaction between firms with and without a family group affiliation can be explained by the “tunneling hypothesis.” For firms affiliated with a family group, we surmise that investors perceive that the proceeds of the rights issue may be misused for the benefit of the controlling shareholder. We also find that higher levels of individual shareholding in the firm are associated with a more positive price reaction to the announcement.

Price Reaction to Rights Issues in the Indian Capital Market

This study examines securities price reaction to announcements of rights issues by listed Indian firms during the period 1997-2005. We document a positive but statistically insignificant price reaction to such announcements. The price reaction is significantly more negative for firms with a family group affiliation compared to firms with no family group affiliation. The notable differential price reaction between firms with and without a family group affiliation can be explained by the tunneling hypothesis. For firms affiliated with a family group, we surmise that investors perceive that the proceeds of the rights issue may be misused for the benefit of the controlling shareholder. We also find that higher levels of individual shareholding in the firm are associated with a more positive price reaction to the announcement.

Did the 2003 Tax Act Reduce the Cost of Equity Capital?

The Jobs and Growth Tax Relief Reconciliation Act of 2003 (the 2003 Tax Act) drastically reduced shareholder level taxes on equity income. If shareholder level taxation is an important component of cost of equity capital, then cost of equity should decrease after the 2003 Tax Act. Using the approach of Dhaliwal, Krull, Li, and Moser (2005) that relies on estimates of implied cost of equity capital, we find that cost of equity decreased by about 1.02% after the 2003 Tax Act. We also show that for firms largely held by institutional investors to whom the tax rate reduction does not apply, the decline in the cost of equity capital is smaller. These results suggest that the 2003 Tax Act may have achieved its intended goal of lowering the cost of equity capital. They also add further evidence to a more fundamental research question, that is, taxes impact valuation.

Dividend Imputation Systems in Industrialized Countries: An Examination of Relative Tax Burdens

Abstract Dividend taxation has been a controversial issue especially since the enactment of the 2003 U.S. legislation entitled “Jobs and Growth Tax Relief Reconciliation Act” (JGTRRA). This paper presents taxonomy of dividend tax systems and illustrates dividend relief practices in the OECD (Organization for Economic Cooperation and Development) countries. None of the OECD countries follow the conduit (i.e., full imputation) system, and the classical system (where double taxation of dividends occurs) prevailed only in one country (Ireland) other than U.S. in 2003. Dividend imputation in most of the OECD countries is only partial and takes place at the shareholder level in the form of tax credit or split rate. The paper also demonstrates a method to compute the effective tax rates (corporate plus individual taxes) on dividends, and presents such rates for the OECD countries. In comparison with the average dividends tax rate of 39.6% in other OECD countries, the U.S. had a rate of 60.7%, which JGTRRA has brought down to 44.8%.

On Target: An Examination of CEO Stock Option Performance Hurdles

In this paper, we have looked at the choice of performance targets using a unique panel database on UK CEO executive option performance targets. Using this data on performance targets along with governance data and financial data for company accounts with year ends from 2001 to 2003, we find that the rate of switch in types of targets and in levels of targets has been slow. Furthermore, those with high levels of institutional shareholding are less likely to use pure EPS targets, perhaps because that pure EPS targets are inconsistent with the relative performance targets predicted by agency theory. We find confirmation of the correlation between levels of targets and average analyst estimates of earnings but at the same time higher forecasts only translate into weakly higher targets. We also conclude it is difficult to predict changes in targets from any variables in our dataset and indeed when changes in target levels occur they tend to be rather large.

Should Chairman and CEO Be Separated? Leadership Structure and Firm Performance in Switzerland

We investigate the valuation effects of leadership structure in Switzerland where, in contrast to the U.S., a separation of the CEO and chairman functions is common. Consistent with the majority of prior research focusing on the U.S., we find no evidence of a systematic and significant difference in valuation between firms with combined and firms with separated functions. We also investigate whether leadership structure is related to firm-level corporate governance characteristics and find a similar curvilinear relationship between leadership structure and managerial shareholdings as is observed between firm value and managerial shareholdings. A possible interpretation is that agency costs associated with a combined function are mitigated by a higher incentive alignment of the CEO/chairman through an adequate level of managerial shareholdings.

Termination Fees in Mergers and Acquisitions: Protecting Investors or Managers?

Unknown less than 15 years ago, termination fees (otherwise called kill fees) are now a commonplace component of merger and takeover agreements. Such fees typically require target firms to pay a monetary consideration to bidders if a merger or takeover agreement is broken. However, institutional investors and shareholder groups have expressed strong reservations about the magnitude of such termination fees in recent large transactions. We argue that the magnitude of termination fees reflects either potential agency problems or economic efficiency considerations. Focusing on a sample of mergers and acquisitions involving Canadian targets that allows us a richer ownership structure environment and an ability to obtain exact information on merger costs and termination fees, we evaluate the determinants of the magnitude of termination fees. First, we show that the Thomson Financial Securities Data's SDC PlatinumTM Worldwide Mergers & Acquisitions Database underestimates the true extent of termination fees. Second, results are consistent with termination fees being an efficient mechanism. Termination fees are found to be higher in transactions where the bidder incurs extensive merger costs, the deal includes a cash component and operating synergies are expected. We also find that deal premium and termination fees act as complements. Third, we do not find strong support for termination fees being a sign of agency problems. Relative termination fees are not related to changes in the CEO's golden parachute the year before the deal or to CEO retention in the acquiring firm. We do find that relative termination fees are greater with lower levels of CEO shareholdings but decrease as CEO ownership increases. Further, mechanisms related to greater monitoring do appear to reduce the level of relative termination fees. Relative termination fees are lower when the target has greater outside directors or higher leverage. Fees are also lower when we have very large family or financial block holdings. However, termination fees may simply act as complements to binding agreements from large shareholders to vote in favour of the deal or tender their shares.