FINS 5526

International Corporate Governance

Emma Jincheng Zhang

School of Banking & Finance
jin.zhang@unsw.edu.au

Session 1, 2017
 FINS 5526
International Corporate Governance

Week 10
Concentrated Ownership & Control
Corporations

Corporation:
o Legally defined, artificial being (a legal entity), separate
from its owners;
o It has many of the legal powers that people have;
o The owners of a corporation have (limited) liability
for obligations the corporation enters into.
Main types of corporations:
o Private companies have limited number of non-
employ shareholders;
o Public companies, without limits on the number of
shareholders, are required to lodge audited financial
statements with the appropriate regulators (e.g. ASIC
in Australia).

3
Corporations (Cont.)

Regulation of corporations:
o Each corporation has a constitution, which specifies the initial
rules that govern how the corporation is run;
o The conduct of corporations, their shareholders, and their
directors and executives are regulated under the Corporations
Act.
Corporate ownership:
o The entire ownership stake of a corporation is divided into
shares;
o Shareholders can receive dividends
o Shareholders (normally) are also entitled to have voting
rights.

4
Corporations (Cont.)

Shareholders, directors and managers:

o Shareholders are the owners of a corporation;
o Shareholders elect directors;
o Directors, on behalf of shareholders, hire/fire top
executives to manage the corporation;
o Directors, on behalf of shareholders, are supposed to
advise and to monitor top managers;
o Managers are responsible for the companys strategic
directions & day-to-day operations.

5
Ownership Disclosure in Australia
Corporations Act requires disclosure of the shareholdings
of substantial shareholders and their associates and the
shareholdings of company directors.

A substantial shareholder (blockholder) is a shareholder

with a relevant interest in at least 5% of the companys
voting shares;

ASX-listed companies must, in their annual reports,

provide
The names of the 20 largest shareholders, as well as the
number of shares held and the percentage of total share capital
held by each one.
The entire distribution of all shareholders

6
Ownership Disclosure in Australia

Morningstar DatAnalysis Premium

o Example 1: Qantas Airways Limited (QAN)
o Example 2: Australia & New Zealand Banking
Group Ltd (ANZ)

7
Ownership in Qantas: Substantial
Shareholders

8
Ownership in Qantas (cont.): Top20
Shareholders

9
Ownership Disclosure in Australia

Nominees accounts & custodian accounts, often appear

on Top 20 Shareholder lists;
Substantial shareholders lists are useful to figure out the
real beneficial/ultimate owners of a company.

10
Ownership Structure: Why Do We Care?
Transparency & Informativeness:
o market participants know who the big
guys are.

Governance issues:
o Large, especially controlling,
shareholders have the power to appoint
directors whose interests to
represent?
o Large, especially controlling,
shareholders have the power to appoint
executives manage the company on
whose behalf?

11
Ownership Structure & Agency Problems

Public corporations with widely dispersed small

shareholders:
o Agency problem: managers vs. shareholders incentive/alignment
problem.

Public corporations with controlling shareholders

and small minority shareholders:
o Ownership and control are concentrated in the hands of controlling
shareholders;
o Agency problem: (managers + controlling shareholders) vs. minority
shareholders entrenchment problem.

12
Separation of ownership and control Why?

1. Initial explanation: a small number of owners cannot meet

the capital needs for the growth of a firm
2. The initial explanation is not convincing
In the 1980s, German and Japanese firms, which have a concentrated
ownership structure, successfully compete with US corporations
3. This leads to the question, what made the ownership more
dispersed in certain countries than others?

13
 Legal origin matters

1. In 1990s, the privatization of state-owned firms in Russia and

Eastern Europe led to a number of problems between controlling
shareholders (or managers) and minor shareholders
The dispersed ownership quickly turned back to concentrated ownership
2. This observation makes academic researchers consider the role of
legal systems in the ownership structure

14
Ownership Structure around the World

Corporate Ownership around the World (Reading

[10.1])
o How common are widely held firms in different countries?
o To the extent that firms have significant controlling
owners, who are they?
o How do these controlling shareholders maintain their
power?
o What explains the differences between countries in their
ownership patterns?

15
Ownership Structure around the World
(cont.)

Corporate Ownership around the World (Reading

[10.1])
o Dispersed ownership structure is uncommon, apart from U.S.
and the UK;
o Most common types of controlling owners governments and
families;
o Their controlling rights >> equity ownership rights;
o Shareholder protection matters
o The ownership is more dispersed in countries in which the minor
shareholders rights are better protected

16
Ownership Structure: Cross-country
Comparison

17
Pushbacks on the legal origin explanation

1. Reverse causality:
US or UK may establish legal protection for the minor
shareholders, after the dispersed ownership became dominant
2. Omitted variable:
Legal protection for investors is less developed in relatively poor
countries, while the economic development is determined by
a number of other factors (e.g., poor endowments, a weak political
tradition, etc.)
3. Classification of legal origins:
The classification of non-European countries is not precise
(e.g., The recent legal system of Latin America has been affected by
US more than France)

18
Who are the controlling shareholders?
Insider
Founders family
Institutional investor
Bank (relevant in Japan)

19 19
Concentrated Ownership Structure:
Microsoft (1995)

Corporate Ownership around the World, by La Porta

et al. (1999), Reading [10.1]

20
Insider Ownership

Insider ownership:
o Percentage of equity held by a corporations directors and
executives as a group; plus
o Percentage of equity held by certain substantial shareholders (e.g.
founding family);
o Role of institutional shareholders can be tricky ( insider or
outsider ??).

Managerial ownership:
o Controlling shareholders often have power to appoint top
managers;
o Sometimes, controlling shareholders are the top managers
large managerial ownership.

21
Insider Ownership & Firm Value
Firm value: Firms market value (market-to-book value
ratio)
ROA: Operating performance
Why would higher ownership held by insiders increase
the firm value?
Address the managerial agency problems
Would higher ownership of insiders deteriorate the firm
value?
Suboptimal risk-taking: the manager may pass up profitable
projects and hoard cash in order to reduce the firms risks
Limit in growth: to finance its growth, a firm may need to sell
its stocks to the investors with well-diversified portfolio

22 22
Research Findings

1. Previous studies on the relationship between insider ownership and

the firm performance provide contrasting results
Some studies find a linear and positive relationship between insider ownership
and the firm performance
Other studies find a non-linear relationship or even no-relationship
2. Why do we have the contrasting results?
If the investors know the optimal level of insider ownership for each firm,
how much ownership would be held by insiders?
Does your answer for the above question explain the contrasting results of
previous studies? If so, can you find any flaw in this explanation?

23
Non-linear Impacts of Insider Ownership

Ownership of HIH:
o 6 out of 13 directors did not own shares;
o Raymond Williams (CEO and founder) held about
2.5%;
o Rodney Adler (director) held about 1%.

Ownership of One.Tel:
o Jodee Rich and Bradley Keeling held 65%
collectively.

24
Concentrated Ownership & Control

Concentrated insider ownership:

o High managerial ownership may provide alignment benefits to
reduce incentive problem;
o High managerial ownership may worsen entrenchment problem,
because managers are too powerful;
o Role of substantial institutional blockholders can be rather
unclear

Concentrated control vs. Concentrated ownership:

o Ownership can be concentrated;
o Control power can be even more concentrated.

25
 Family firms

1. Family firms can be defined in various ways:

Anderson and Reeb (2003): family firms are those with dominant shareholder
as
a family member
Morck and Yeung (2004): family firms are those controlled by the founder or
his/her heirs
2. Why do family firms (potentially) outperform widely held firms?
The presence of controlling shareholders mitigates managerial agency
problems
Family shareholders tend to have longer time horizons than public investors
(i.e., family shareholders are willing to maximize long-term profit rather than
short-term earnings)
Family members can manage corporate affairs smoothly
Families may have a strong political connection

26
Ways to Enhance Control (>> Ownership)

Cash flow stake (ownership claim):

o The proportion of the firms net profits attributable to the owner;
Control rights (voting power):
o The proportion of voting rights of the owner;
Definition of control
o 20% of voting rights: partial control (10% in some country);
o 50% of voting rights: majority/absolute control.

Cash-flow and control rights of the controlling shareholder

can differ:
o The largest direct (or indirect) shareholder capable of exercise control
over a companys strategies and affairs.

27
Control-Ownership Divergence

Different mechanisms can be used to enhance

control of the large inside shareholders (especially
the controlling owner):
o Dual-class shares
o Pyramid shareholding scheme
o Cross-shareholding scheme
o Voting agreements
o Disproportionate board representation
=> Family members can control a firm by holding
less than 50% of outstanding shares

28
Dual-class Shares

Dual-class shares
o In addition to the regular one-share-one-vote
o Multiple-voting shares: dividends plus extra
votes;
o Non-voting shares: earn dividends but do not
carry votes, shares cannot be used to elect
directors;

29
Dual-class Shares: Examples

Ford Motors:
o Ford Family owns about 4% of equity;
o They control 40% of the voting power.
NY Times:
o Class A shareholders can elect up to 1/3 of directors;
o Family Trusts, owning most of super-voting class B
shareholders, can elect more than 2/3 of directors.
Facebook:
o Mark Zuckerberg owns 28% of Facebook equity;
o He has 57% of voting rights, upon the successful IPO.

30
Dual-class Shares: Good or Bad?

Argument for?

Argument against?

31
Dual-class Shares: Good or Bad? (Cont.)

Argument for?
o Insiders (founding CEOs, in particular) have
better knowledge;
o Insiders might have longer-term vision.

Argument against?
o Could be easily used to entrench managers
a different kind of misalignment.
o Make some investors 2nd class citizens;

32
Other Mechanisms

Pyramid shareholding scheme

o A owns 50% of B, and B owns 50% of C;
o Cash flow right? Control right?

Cross-shareholding scheme
o A owns 30% of B, and B owns 25% of A;
o Cash flow right? Control right?

33
Pyramids & Cross-shareholdings

Pyramid shareholding scheme

o A owns 50% of B, and B owns 50% of C;
o Cash flow rights of A in C = 50% 50% = 25%;
o Control rights of A in C = 50%, majority control.

Cross-shareholding scheme
o A owns 30% of B, and B owns 25% of A;
o Cash flow rights of A in B is complicated;
o Because A has partial control of B, but B also has partial control of A

34
 Pyramidal Ownership Structure: Samsung
Group (2002)

Samsung Samsung
Samsung Electronics Corp
Life Ins Cheil
Comm.
Samsung
Mech. Elec Samsung Samsung
S-one SDI Foundations

Samsung Samsung
Heavy Ind. Card
Samsung
Samsung Hotel Security
Everland Samsung
Shilla Prec.Chem
Samsung
F&M Ins
Samsung
Techwin
Cheil Samsung Samsung
Textile Engineering Capital
35
 Voting agreements: Washington Post

In 2000, Katharine Graham and her four adult children held

investment and voting power over 44.9% of all shares outstanding in
WP. Berkshire Hathaway Inc., of which Warren Buffett and his wife
owned approximately 33.6%, held investment power over 18.3%
shares of Washington Post. Pursuant to an agreement dated 1977 and
amended and extended in 1996, Warren Buffett, Berkshire, and its
subsidiaries had granted Katharine Grahams son Donald Graham a proxy
to vote such shares at his discretion. As a result, the Graham family
actually had voting power over 63.2% of WPs shares, but
investment power over 44.9%.
- Villalonga and Amit (2009) How are US family firms controlled?,
Review of Financial Studies

36
Disproportionate board representation: NYT

in the case of The Now York Times Co. In 1998, there were two
classes of common stock, A and B, which represented 99.56% and 0.44% of
the total shares outstanding, respectively. Each share was entitled to one
vote, but class A shareholders could only elect five of the fifteen directors,
while class B stock holders were entitled to elect the other ten, or two-
thirds of the entire board. The Ochs-Sulzberger family owned
17.9% of the companys total shares outstanding, but 88.7% of all
class B shares, which effectively enabled it to elect the two-thirds of
the board reserved for class B stock holders.

- Villalonga and Amit (2009) How are US family firms controlled?,

Review of Financial Studies

37
Managerial/Insider Entrenchment Problem

Governance implications:
o Insiders (the controlling shareholder and associated managers)
may have low cash flow claims, but they retain large voting
rights;
o Managers and controlling owner are often in the same camp;
o This allows the controlling owner to expand the business empire
with the help of other shareholders but still maintaining the
power to control;
o The difference creates an incentive to expropriate minority
shareholders.

38
Do family firms have better governance?

1. Controlling shareholders are supposed to mitigate agency problems,

because their wealth is tied up in the firm
2. The wedge between cash-flow and voting rights imply that
family members may control the firm without tying their wealth up
in the firm
3. Other investors may not be able to discipline the manager and
controlling shareholders of the family firm, because they are
entrenched
4. Overall, the effect of family ownership on the governance is
questionable

39
 Research Findings

1. The effect of family ownership on the firm performance depends on

the mechanism that families use to create the wedge between their
cash-flow and voting rights
2. Dual-class stock is negatively associated with the firm performance
3. Pyramid and voting agreement are positively associated with the firm
performance
Pyramid allows the firm to use the internal cash flows or the strategic synergy
between subsidiaries more efficiently
Pyramid also makes the firm more accessible to private equity funds
Before making voting agreements, the investors ensure that families work for
the interest of other shareholders

40
 Notes on the research findings

1. In countries with better protection for investors (e.g., United

Kingdom), firms become widely held by investors as they get older
2. In Continental Europe, family ownership is more persistent
3. There is a significant time-series variation in the ownership structure
in Canada
The rise in family ownership since 1970 is partially attributed to the merger
wave driven by family pyramid firms
This may imply that the legal origin is not the only determinant of ownership
structure

41
Outside Shareholders

Outside shareholders (e.g. banks, managed

funds, foreign investors, etc.) respond to
agency problems:
o Do nothing ?
o Cut and run ?
o Stay and fight ?
The last option is costly:
o Other investors may free-ride on those who fight;
o It is only viable for shareholders who have large
stakes and thus capable to monitor and intervene.

42
Large Outside Shareholders

Advantages of (active) large outside shareholders :

o Monitor managers;
o More committed to the firm.
However:
o Holding large percentage of shares is costly for them, and
concentrated ownership inhibits trading liquidity;
o Large shareholders could also become a problem:
o They could ally with managers;
o Large voting power could permits extraction of corporate
resources for their own benefits.

43
Going into the future
For next weeks lecture
Institutional Investors
Cross-country Comparisons

44