Pyramidal Ownership Structure Research Articles

Impact of state ownership and control mechanisms on the performance of group affiliated companies in China

This paper examines the moderating impact of state ownership and group control mechanisms on the relationship between diversification and performance of companies affiliated with large business groups in China. We find that the state ownership has enhanced the performance of group affiliated companies when they adopted higher degrees of diversification. We also find that cash flow rights have a positive impact on the performance of companies with lower degrees of diversification while in general group control rights have a negative impact on the performance. These results suggest that a group’s control mechanisms, derived from pyramid ownership structures, enable the dominant owners to expropriate the value from minority shareholders or tunnel corporate resources for their own interest.

The Impact of Corporate Governance Structures on the Corporate Investment Performance in Turkey

In spite of the fact that most research has concentrated on the typical agency problem between managers and dispersed shareholders, in many countries large shareholders are much more frequently observed than firms with dispersed ownership structures. While large shareholders are perceived as a potential solution to the typical agency problem between managers and dispersed shareholders, less research has been done on the costs of large shareholders. One important issue in this literature is that deviations of cash flow rights from voting rights often result in substantial value discounts. In this paper we test for the impact of such deviations on corporate investment performance in Turkey. To measure corporate investment performance we estimate returns on investment relative to company costs of capital, a methodology that overcomes the endogeneity problem, which is known to contaminate results in the empirical corporate governance literature. Consistent with existing studies, we find that the average Turkish listed company has a return on investment which is less than its cost of capital. We also report significantly better investment performance for companies that do not deviate from one share–one vote by using pyramidal ownership structures, dual‐class shares and other devices that enhance the control power of large shareholders beyond their cash flow rights. We also find that business group membership improves the investment performance and relative market valuation of companies.

The Measurement of Firm Ownership and its Effect on Managerial Pay

This paper uses German evidence to address two questions about corporate governance. The effects of ownership on corporate governance have received much recent attention, but very little of this has been devoted to the appropriate way to measure firm ownership. The results of this paper show that the conclusions reached about the effects of ownership on corporate governance can depend critically on the particular ownership measure used, and that the widely-used weakest-link principle is wholly unsatisfactory as a means of dealing with the issues raised by pyramid ownership structures. The paper also shows that greater ownership concentration typically weakens the link between managerial pay and firm profitability. This is inconsistent with the hypothesis, emphasised in the recent literature on the USA, that large owners are a complement to, rather than a substitute for, such a link.

A Theory of Pyramidal Ownership and Family Business Groups

We provide a rationale for pyramidal ownership (the control of a firm through a chain of ownership relations) that departs from the traditional argument that pyramids arise to separate cash flow from voting rights. With a pyramidal structure, a family uses a firm it already controls to set up a new firm. This structure allows the family to 1) access the entire stock of retained earnings of the original firm, and 2) to share the new firm's non-diverted payoff with minority shareholders of the original firm. Thus, pyramids are attractive if external funds are costlier than internal funds, and if the family is expected to divert a large fraction of the new firm's payoff; conditions that hold in an environment with poor investor protection. The model can differentiate between pyramids and dual-class shares even in situations in which the same deviation from one share - one vote can be achieved with either method. Unlike the traditional argument, our model is consistent with recent empirical evidence that some pyramidal firms are associated with small deviations between ownership and control. We also analyze the creation of business groups (a collection of multiple firms under the control of a single family) and find that, when they arise, they are likely to adopt a pyramidal ownership structure. Other predictions of the model are consistent with systematic and anecdotal evidence on pyramidal business groups.

Just Another Gray Sheep?

This article addresses the following key points: Holding-company and pyramidal ownership structures make related-party transactions more prevalent in Europe, Asia, and Latin America. Minority shareholders may be legally disadvantaged in civil law countries. World opinion about related-party transactions is converging around general principles of transparency and fairness.

The Emergence of Corporate Pyramids in China

We examine the pyramidal ownership structure of a large sample of newly listed Chinese companies controlled by local governments or private entrepreneurs. Both types of the owners use layers of intermediate companies to control their firms. However, their pyramiding behaviors are likely affected by different property rights constraints. Local governments are constrained by the Chinese laws prohibiting free transfer of state ownership. Pyramiding allows them to credibly decentralize their firm decision rights to firm management without selling off their ownership. Private entrepreneurs are constrained by their lack of access to external funds. Pyramiding creates internal capital markets that help relieving their external financing constraints. Our empirical results support these conjectures. Local governments build more extensive corporate pyramids when they are less burdened with fiscal or unemployment problems, when they have more long-term goals, and when their firm decisions are more subject to market and legal disciplines. The more extensive pyramids are also associated with smaller underpricing when the firms go public. Entrepreneur owners construct more complex corporate pyramids when they do not have a very deep pocket - as indicated by whether they are among the top-100 richest people in China.

Pyramiding effect on firm’s investment decision among Malaysian distress companies

It is documented by La Porta, Lopez and Shleifer (1999) that ultimate owners, around the world usually control an array of affiliated companies through hierarchical intermediary corporations forming a Pyramidal Ownership Structure. A direct result of this pyramidal ownership structure is divergence of cash flow rights from control rights in the hand of the largest shareholders (Claessens, Djankov and Lang 2000). This paper investigate the impact of this separation of cash flow rights from control rights resulting from this pyramidal forms of ownership structure on firm’s investment decisions. In particular, our objective is to examine whether such separation affects the investment decisions among Malaysian listed distress Companies. Our findings lends support to the over investment problem, where by the separation of cash flow rights and control rights have led to the increase of inefficient investment among the distress companies. The main source of financing for this inefficient investment activity is the firm’s retained earnings. Consequently, the exploitation of such firm’s resources in order to finance these inefficient investment activities of the ultimate owner’s then lead to negative market valuation.

Does pyramiding have an impact on firm’s capital structure decision among Malaysian distress companies?

It is documented by La Porta, Lopez and Shleifer (1999) that ultimate owners around the world usually control an array of affiliated companies through hierarchical intermediary corporations forming pyramidal holdings. A direct result of this pyramidal ownership structure is divergence of cash flow rights from control rights in the hand of the largest shareholders (Claessens, Djankov and Lang 2000). This paper investigates the impact of this separation of cash flow rights from control rights resulting from these pyramidal forms of ownership structure on firm’s capital structure. In particular, our objective is to examine whether such separation affects the financing decisions among Malaysian listed distressed companies. Even though it is not conclusive our findings somewhat lend support to the leverage-increasing non-dilution entrenchment effect on corporate leverage, whereby the separation of cash flow rights and control rights leads to the increase of leverage among the distressed companies. Consequently, excessive use of leverage in order to protect ultimate owner’s dominance in these companies then leads to disastrous financial valuation.

The effect of capital structure when expected agency costs are extreme

This paper conducts powerful new tests of whether debt can mitigate the effects of agency and information problems. We focus on emerging market firms for which pyramid ownership structures create potentially extreme managerial agency costs. Our tests incorporate both traditional financial statement data and new data on global debt contracts. Our analysis is mindful of the potential endogeneity between debt, ownership structure, and value, and it takes into account differences in the debt capacity of a firm's assets in place and future growth opportunities. The results indicate that the incremental benefit of debt is concentrated in firms with high expected managerial agency costs that are also most likely to have overinvestment problems resulting from high levels of assets in place or limited future growth opportunities. Subsequent internationally syndicated term loans are particularly effective at creating value for these firms. Our results support the recontracting hypothesis that equity holders value compliance with monitored covenants, particularly when firms are likely to overinvest.

How Weak is the Weakest-Link Principle? On the Measurement of Firm Owners' Control Rights

The paper argues that the weakest link principle, which has been widely used as a measure of ultimate owners' control rights, has a number of serious problems. A theoretically more satisfactory method of measuring control rights, based on voting power indices, is proposed, and the different measures are compared using a sample of large listed German firms. The different measures produce very different results. But, whichever measure is used, taking account of pyramid ownership structures has little effect on the values of control and cashflow rights. The results also show that neither first-tier nor ultimate control rights measures are adequate on their own, suggesting that further work on ownership structure and pyramids is required to obtain satisfactory measures of large owners' control rights.

Mergers and Acquisitions in Germany - Social Setting and Regulatory Framework

The paper describes the legal and economic environment of mergers and acquisitions in Ger- many and explores barriers to obtaining and executing corporate control. Various cases are used to demonstrate that resistance by different stakeholders including minority shareholders, organized labour and the government may present powerful obstacles to takeovers in Ger- many. In spite of the overall convergence of European takeover and securities trading laws, Germany still shows many peculiarities that make its market for corporate control distinct from other countries. Concentrated share ownership, cross shareholdings and pyramidal ownership structures are frequent barriers to acquiring majority stakes. Codetermination laws, the supervisory board structure and supermajority requirements for important corporate deci- sions limit the execution of control by majority shareholders. Bidders that disregard the Ger- man preference for consensual solutions and the specific balance of powers will risk their takeover attempt be frustrated by opposing influence groups.

Ownership Patterns and Control in Turkish Listed Companies

The purpose of this paper is to document the prevalent ownership concentration, structure and control in the top 100 companies listed on the Istanbul Stock Exchange. The results are discussed in the context of emerging corporate governance trends in Turkey. Where appropriate, comparisons with other countries are provided.The results of the study indicate that ownership of Turkish companies is highly concentrated, families being the dominant shareholders. The separation of ownership and control among Turkish companies is mainly achieved through pyramidal ownership structures and the presence of big business groups. However, the cash flow and voting rights in Turkish companies are relatively more aligned compared to other family–ownership–dominated insider–system countries.

The Effect of Capital Structure When Expected Agency Costs are Extreme

We provide new evidence that debt creates shareholder value for firms that face agency costs. Our tests are unique in two respects. First, we focus on a sample of firms with potentially extreme agency problems. We study emerging market firms where the routine use of pyramid ownership structures provides an acute separation of management cash flow rights and control rights. Second, we argue that not all debt is the same. Using new data on global debt issuance, we find that the type of debt that positively impacts shareholder value is the type that closely monitors management. This combination of a sample of firms with extreme expected agency problems and detailed information on the different types of debt allows us to construct powerful tests of whether debt can mitigate the effects of agency and information problems. Among other results, we find that the abnormal returns resulting from syndicated term loans (which provide monitoring) are significantly related to the extent of the separation of ownership and control. Our results are consistent with the idea that debt creates value because it reduces the agency costs associated with overinvestment.

Ownership Structure, Corporate Governance, and Firm Value: Evidence from the East Asian Financial Crisis

We study the effect of ownership structure on firm value during the East Asian financial crisis that began in July 1997. The crisis represents a negative shock to the investment opportunities of firms in these markets that raises the incentives of controlling shareholders to expropriate minority shareholders. Moreover, the large separation between cash flow and control rights that often arise from the use of pyramidal ownership structures and cross-holdings in these markets suggests that insiders have both the incentive and the ability to engage in expropriation. Using data from over 800 firms in eight East Asian countries, we find evidence consistent with this view. Tobin's Q ratios of those firms in which minority shareholders are potentially most subject to expropriation decline twelve percent more than Q ratios in other firms during the crisis period. A similar result holds for stock returns - firms in which minority shareholders are most likely to experience expropriation underperform other firms by about nine percent per year during the crisis period. Further, during the pre-crisis period we find no evidence that firms with a separation between cash flow rights and control rights exhibit performance changes different from firms with no such separation. All of these results are robust to controls for country and industry effects, as well as proxies for differences in risk across firms and the strength of the country's legal institutions. The evidence indicates that corporate ownership structure plays an important role in determining the incentives of insiders to expropriate minority shareholders during the times of declining investment opportunities. Our results add to the literature that examines the link between ownership structure and firm performance and provide additional guidance to policymakers engaged in the ongoing debate about the proper role and design of corporate governance features and legal institutions in developing economies.

Analyst Activity Around the World

In this paper we provide evidence on analyst activity and performance in 47 countries around the world, including several emerging market economies. Our empirical analysis first demonstrates wide variation in the extent and accuracy of analyst activity across our sample countries. A handful of country-specific measures, such as the average firm size, the size of the stock market relative to country GDP, the quality of accounting disclosures, and the country's legal origin, explain a sizeable part of this variation. For a subset of 15 emerging markets in Asia and Latin America, we also investigate the proposition that the business groups, commonly found in these regions, which often take the form of pyramidal ownership structures, hamper analyst activity and their forecast performance. We find that, after controlling for other factors, the earnings of group affiliates are indeed harder to forecast than those of unaffiliated firms. However, group affiliates are more likely to be followed by analysts. Our analysis also shows that the magnitude of the group effect is small, and that it is overshadowed by country-specific contextual factors. Overall, our results are consistent with the view that the transparency problem in an economy is primarily influenced by its legal and information context, rather than by how companies are organized in the economy.

Shareholding Concentration and Pyramidal Ownership Structures in Belgium: Stylized Facts

This paper provides an overview of the main characteristics of the ownership structures of the Belgian companies quoted on the Brussels stock Exchange. Prior to the changes in corporate law regarding ownership disclosure in 1989 little was know about ownership and control. We show that the Belgian equity market has some similarities with equity markets of its Continental European neighbors : relatively few Belgian companies are listed and there is a high degree of ownership concentration. In addition, control is levered via pyramidal and complex ownership structures. Ultimate owners in such control chains are not only families and industrial companies but predominantly widely held holding companies that with relatively small cash flow rights, exercise substantial control rights.

The Reputational Penalty Firms Bear from Committing Criminal Fraud

Introduction Optimal penalties for corporate fraud require that firms face expected penalties equal to the total social costs of the crime. Yet formal courtimposed sanctions for committing fraud often represent a small fraction of the damage produced by the fraud. Sheer and Ho (1989), for example, estimate that the median and mean ratios of criminal fines to the private loss from private fraud were 0.14 and 0.73 in 1988. The corresponding median and mean ratios for government procurement fraud were 0.29 and 1.60. Including criminal restitution raises the median dollar sanction-to-loss ratio for private fraud to 0.84 and for government procurement fraud to 0.68. These ratios are for private parties convicted of fraud. The ratio of the expected court-imposed penalty to the social cost of the fraud is undoubtedly smaller. Particularly when compared to other crimes such as environmental pollution, where the median ratio of criminal fines to private loss is 3.71, the penalty for fraud seems surprisingly low. The perceived underpunishment of corporate frauds has recently affected public policy. Reflecting popular opinion that existing penalties were too low, the US Sentencing Commission – the federal agency responsible for setting the penalty guidelines used by judges – established corporate sentencing guidelines in 1991 that raised median corporate fraud penalties by over twentyfold. This article criticises the conventional wisdom about corporate fraud in two ways. First, we explain that the typical optimal criminal penalty for private corporate fraud is small because the external effects of such frauds are usually small. An increase in criminal penalties for corporate fraud can do more harm than good because it encourages the substitution of criminal penalties for reputation as a mechanism to police fraudulent behaviour.