Empirical Study on Ownership Structure and Firm Performance

Transcription

1 Empirical Study on Ownership Structure and Firm Performance Arunima Haldar Doctoral Student School of Management Indian Institute of Technology, Mumbai SVD Nageswara Rao Associate Professor School of Management Indian Institute of Technology, Mumbai Key Words Corporate Governance Ownership Structure Firm Performance Concentration Owner Controlled Manager Controlled BSE 500 Abstract Researchers have come up with varied assertions with regard to the relationship between ownership structure and firm performance. Studies show positive, negative as well as both positive and negative relationship at differing levels of equity holdings by managers. Majority findings argued about owner controlled firm s performance being better than manager controlled ones, yet lacking statistical assertion for the same. This research work is empirically investigating the efficiency of ownership groups in enhancing corporate performance by analyzing firms traded on Bombay Stock Exchange (BSE). We are using BSE 500 index firms to create an unbalanced annual panel data from 2001 to By using fixed and random effect techniques of panel data analysis, we wish to contribute towards the enduring debate of corporate governance as to which ownership group maximizes firm performance. This debate has so far, largely remained inconclusive with different researchers advocating varied view points. Introduction The relationship between ownership structure and firm performance has received substantial notice in the finance literature. Berle and Means (1932) are among the first breed of researchers to draw attention to the fact that firm performance is inversely affected as diffuseness of the ownership structure enhances. Succeeding studies by scholars have either supported or rejected this argument. Studies throughout the world have focused on different aspects of ownership and their effects on firm performance. Differing viewpoints on the ownership debate by varied researchers has created a dilemma as to which ownership group maximizes firm performance. While Jensen (1993), Chew (1997) have tried to empirically prove that large investors with long term interest in firms help in improving performance in a market based economy. Others like Rajan and Zingales (1999) have criticized the relationship model of ownership structure as the main cause of East Asian Debacle. Thus arguments vary as per the prevailing market system. Research Paper 27

2 Indian Journal of Corporate Governance Highly efficient markets attract agency cost whereas weak markets have the possibility of principals expropriating shareholder s value. Literature on the latter is evidently missing in the finance literature since majority studies are conducted with regards to developed market model economies or relationship-centered, multi-tiered ownership economies. Our study with regard to the developing country, India sheds some light on the governance practices in transition economies. India is a typical example where majority ownership is closely held. The primary problem in such closely held firms would be the controlling shareholder s abuse of the minority shareholders Shleifer and Vishny (1997). Our study of Corporate Governance in India adds to the literature due to the unique governance issues which are not present in the developed nations. Recent efforts by researchers in studying the impact of different ownership groups on firm performance has led to the hypothesis that Indian markets are inefficient in controlling owner expropriation of small shareholder s value. Also, institutional investors do fail to effectively monitor owner and managerial behaviour. Khanna and Palepu (2000), Kumar (2004) observe that the firm performance, both in terms of accounting as well as market measures, declines with group diversification and then increases once the diversification exceeds a certain level. In India, usually a business endeavor starts as proprietorship or partnership or closely held limited company. But as company grows, the closely held business house approaches market to raise equity capital through IPO (Initial Public Offering) route. This is the first stage when the diffusion of ownership occurs. Subsequently it goes for further issue of share capital (seasoned offering) depending upon fund requirement for capital investment and other factors like choice of capital structure, signaling impact of new issue and so on. The owners of the closely held company taking it to the stage of IPO are promoters in Indian context. They are considered insiders till they dilute their stake through disposal of their holding in the secondary market. The persons or bodies other than the promoters having investment in the share capital are non-promoter or non-promoter shareholders. Our work continues along these lines of enquiry. It examines the link between firm performance and ownership structure for a panel of BSE 500 Index firms over the years 2001 to We take promoters and non promoters shareholdings as a proxy to concentration and diffuseness of ownership respectively. Market related as well as accounting returns are taken as proxies to performance. BSE 500 Index firms are used for our study as it represents 93% of the total market capitalization on BSE. The Index also covers almost all major industries of the economy. Thus our study gives a fair view of Indian corporate world. Volume 4, No.2, July-December 2011 The remainder of the paper is organized as follows. Section 2 briefly reviews the existing literature. Data and variable constructions are presented in Section 3. The methodology used and the obtained results are presented in Section 4. Finally, some concluding remarks are presented in Section 5. Literature Researchers started studying the impact of ownership structure on firm performance way back in 1968 Kamerschen (1968) and Mosen et al (1968). Contributions by Oliver Hart (1995), Oliver Williamson (1988) and Jensen and Meckling (1976) have helped us appreciate the theory of separation of ownership and control. While few researchers focused on locus of control for their study, others have studied the role played by institutional investors, foreign investors and retail shareholders. Within the conflicts of interest framework, seven major arguments have emerged that explain the literature on the impact of ownership structure on 28

3 Empirical Study on Ownership Structure and Firm Performance firm performance Bhasa (2006). The arguments are incentive alignment, takeover premium, entrenchment, cost of capital, efficient monitor, Stulz s integrated theory, and Morck et al s combined theory. These arguments explain the motivations that govern the management and owners while running the organization in Anglo-Saxonic framework. Earlier studies tried to understand whether separation of ownership and control really had effect on firm performance. Mixed evidence could be seen on the performance of the owner controlled or manager controlled firms. In some cases owner controlled firms performed better, whereas the vice versa was seen in other studies. This elucidates that performance differs from firm to firm, industry to industry and country to country despite the uniformity in composition of ownership at a broader level. Thus we include some significant studies in our review. Morck et al. (1988), taking directors shareholding as a measure of ownership concentration and holding both Tobin s Q and accounting profit as performance measure of 500 Fortune companies and using piece-wise linear regression, found a positive relation between Tobin s Q and board ownership. They observe that Tobin s Q rises as board ownership increases from 0 to 5%, decreases between 5% and 25% and once again rises, though slowly, beyond 25%. The non-monotonic relationship explains two different phenomena of alignment and entrenchment. As shareholding rises initially performance improves because of the alignment of monetary incentives between the manager and other equity owners. But after a certain limit mangers may become complacent and thus may not try to put adequate efforts for the firm s growth. But again at higher levels, incentive effect may align their thoughts towards performance as it might multiply opportunities to appropriate corporate wealth. Loderer and Martin (1997) took shareholding by the insiders (endogenous) as a measure of ownership and Tobin s Q as performance measure. They found (through simultaneous equation model) that ownership does not predict performance, but performance negatively predicts ownership. We infer that since Q ratios measure growth opportunities already capitalized in the stock price, managers are incentivized to liquidate their own firm stock ownership and diversify their wealth. Cho (1998) also found that firm performance had effect on ownership structure (signifying percentage of shares held by directors), but not vice versa. Thus ownership may not be an effective incentive mechanism to induce managers to make value maximizing investment decisions. Demsetz and Villalonga (2001) investigated the relation between the ownership structure and the performance (average Tobin s Q for five years ) of the corporation (Considering ownership multidimensional and also treating it as an endogenous variable). No significant systematic relation could be ascertained using Ordinary Least Squares (OLS) and Two-stage Least Squares (2 SLS) regression model. According to them, The market responds to forces that create suitable ownership structures for firms, and this removes any predictable relation between empirically observed ownership structures and firm rates of return. Welch (2003), applying the model of Demsetz and Villalonga (2001), examined the relationship between ownership structure and firm performance of Australian listed companies. Her OLS results suggest that ownership of shares by the top management is significant in explaining the performance measured by accounting return but not by Tobin s Q. However, when ownership is treated as endogenous, the same is not dependent upon any of the performance measures. Kapopoulos and Lazaretou (2007) tried the model of Demsetz and Villalonga (2001) for 175 Greek firms for the year 2000 and found that concentrated ownership structure leads to higher profitability. Research Paper 29

4 Indian Journal of Corporate Governance Ganguli and Agrawal (2009) analyzed the relationship between firm performance and ownership structure in respect of Indian mid-cap listed companies following the models of Demsetz and Villalonga (2001) and Kapopoulos and Lazaretou (2007) with certain alterations. They studied the impact of ownership on performance and vice versa. The study concludes that in the case of listed mid-cap Indian companies, there exists a systematic positive relationship between firm performance and concentration of holding and vice versa in a statistically significant manner. We follow the model of Ganguli and Agrawal (2009) by taking promoter and non promoter holding as a measure of concentration and diffuseness as a proxy for ownership structure. While their model concentrated on market based performance, we further extended our study to see the impact of both market based (Tobin s Q) and accounting based (ROA, ROCE) returns. Their study was confined to one year data on mid cap companies, but we enhanced it to eight years data on BSE 500 companies. Thus we contribute significantly to the existing literature. Volume 4, No.2, July-December 2011 Data Sources and Sample Selection We study the effect of ownership structure on firm performance taking Indian Corporate Sector firms. Indian corporate sector offers us a large number of corporate firms, thus leading to large sample statistical analysis. Indian firms unlike their other counterparts, maintain their shareholding pattern over the study period, thus enabling identification of ownership affiliation of each sample firm Patibandla (2002). With a well established regulatory framework for more than four decades, numerous initiatives by SEBI, accounting system at par with advanced countries, India has paved its way to the highest standards of corporate governance. The firm-level data is primarily obtained from the corporate database prowess maintained by CMIE (Center for Monitoring the Indian Economy). The annual data used in the analysis consists of BSE 500 firms listed on the Bombay Stock Exchange (BSE), for which we could get their historical share holding pattern. Firms within financial services segments are not considered due to difference in laws governing them. Public Sector firms are also not included in the analysis as their performance is influenced by a large number of social obligations and regulations, which may be difficult to account for. We analyze data from 2001 to We also restrict our analysis to firms which have no missing data (on both independent and dependent variables) for at least 2 consecutive years. There are 685 firms in our sample, for which there is data required for at least 2 consecutive years. For this unbalanced panel of 3332 observations, we collect the following additional data for each firm observation: advertising, distribution, marketing and research and development (R&D) expenditure as a percentage of sales. Despite the problem of attrition and missing data, our sample provides several distinct advantages over the samples used in earlier studies. We perform our analysis after restricting the performance measure to lie between 1st and 99th percentile to tackle the problem of outliers, which may be influential. This leaves us with 3332 observations for 4000 observations. Key Variables Independent Variables Earlier studies suggest varying measures of ownership. We follow the model suggested by Demsetz and Villalonga (2001). They suggested two ownership variables, viz., the shareholdings of the firms five largest shareholders and the shareholding of the firm s top management as 30

5 Empirical Study on Ownership Structure and Firm Performance criteria for concentration of ownership. We modified the model as per Indian scenario given by Ganguli and Agrawal (2009). Thus, the proxy used for ownership is the equity-holding structure. Thus, we include two ownership variables namely promoter shareholding and non promoter shareholding. Dependent Variables Different researchers have used different firm performance proxies. While Morck et al.(1988), McConnell et al. (1995) and a host of other researchers have used Tobin s Q, Demsetz and Lehn (1985), Denis and Denis (1994) and other researchers have used accounting measures of performance. While the accounting measures portray the historical performance of the firm, market related performance proxies capture the expected future performance of the firm. A rapidly growing firm may have low accounting returns but its market performance can surpass the accounting performance proxies. On the other hand, firms those are well established and have strong accounting returns might perform weakly in terms of market-based returns. Hence, different proxies for firm performance may produce different results with the same ownership structure Wan (1999). Our study uses three performance variables. Two measures are based on accounting information and one measure is based on market-related information. Though some firms are found to perform well as per their accounting information, markets may punish them due to some sentiment or the other. Hence using a market-related measure as a performance measure crosschecks the results derived from the analysis of accounting-based information. The study uses return on assets (ROA) and return on capital employed (ROCE) as accountingbased performance measures. On the other hand, Tobin s Q has been employed as the market-based performance measure. Control Variables The other possible determinants of firm performance which are not captured by ownership variables are included as control variables. The control variables used in the study have been selected with reference to those employed in earlier empirical studies. We use R&D Intensity, Advertising Intensity, Distribution Intensity and Marketing Intensity as the control variables. These expenditures may yield positive returns in future, thus enhancing firm performance. These variables also control for opportunities of discretionary expenditure by management. These are measured as a percentage of sales. These variables are used to control the operational aspects, based on empirical performance studies and literature reviewed in Cui and Mak (2002). Empirical Model Our basic objective is to find out how firm performance gets impacted by ownership structure, i.e., concentration and diffuseness of shareholding pattern. We take performance (Tobin s Q, ROA and ROCE) at the end of fiscal year as endogenous variable and promoters and non-promoters shareholding representing concentration and diffuseness respectively as exogenous variables. If promoters holding is p, by definition non-promoters holding will be (1 p). We shall be confronted with severe multicollinearity problem if both the promoters and the non-promoters shareholdings are included as exogenous variables in the same regression equation. Research Paper 31

6 Indian Journal of Corporate Governance The problem can be avoided if we construct two separate regression models, following Ganguli and Agarwal s model whereby in the first equation we take promoters holding as exogenous variable, while in the other we take non-promoters holding as exogenous. Equation-1 shows the impact of concentration on performance, and the other equation reveals the impact of diffuseness on performance. Generalised Equation is given below. Performance it = α + ß(Ownership) it + γx it + δ i + ε it Panel Data Analysis We regressed the dependent variable Tobin s Q, ROA and ROCE on various explanatory variables. Random Effects or Fixed Effects The use of either of the above models hinges on whether the cross section specific error components are correlated with the explanatory variables. If they are correlated, use of Random Effects or Error Component Model would be inappropriate. For testing this, we employ the Hausman Test for cross section random effects. We conduct a Random effect and Hausman test and later conducted panel analysis using fixed effects. Firstly we conducted on promoters as independent variable with respect to Tobin s Q, ROA and ROCE. Then we conducted on non promoter s as independent variable with respect to Tobin s Q, ROA and ROCE. Empirical Results Table-1: Results with Promoter s Holding as Exogenous Variable Performance it = α + ß(Promoter Holding) it + γx it + δ i + ε it Explanatory Variable Tobin s Q ROA ROCE Constant ( ) ( )* ( ) Promoters Holding ( )** ( )*** ( )* Advertisement Expenses ( ) ( )* ( )*** Marketing Expenses ( ) ( )* ( )*** Volume 4, No.2, July-December 2011 Distribution Expenses Research and Development Sales ( ) ( )* ( )* ( ) ( ) ( )* ( ) ( ) ( )* 32

7 Empirical Study on Ownership Structure and Firm Performance Table-2: Results with Non Promoter s Holding as Exogenous Variable Performance it = α + ß(Non Promoter Holding) it + γx it + δ i + ε it Explanatory Variable Tobin s Q ROA ROCE Constant ( ) ( )** ( )* Non Promoters Holding ( )** ( )* ( )* Advertisement Expenses ( ) ( )*** ( )*** Marketing Expenses ( ) ( ) ( )*** Distribution Expenses ( ) ( ) ( ) Research and Distribution ( )* ( ) ( ) Sales ( )* ( )* ( )* Significance at *1%, ** 5%, *** 10% From the results in the table it is clear that firm performance is directly related to promoters holding and inversely related to non-promoters holding. The control variable like sales is significant in all the cases related to promoter s holdings as well as non-promoter s holdings. Conclusion This study has examined empirically the relationship between the ownership structure and firm performance using an unbalanced panel of BSE-500 Index firms over We document that unobserved firm heterogeneity explains a large fraction of cross-sectional variation in firm performance that exists among Indian corporate firms. From the results obtained we can conclude that promoters holding is a major contributor in the firm performance. There is a significant and positive relation between firm performance and promoters holding. Thus, nonpromoters holding do not contribute much to the firm performance. References Berle, A. & Means, G. The Modern Corporation and Private Property, Harcourt, Brace and World Publication, New York [accessed on April 22, 2010]. Chew, D (1997) Studies in International Corporate Finance and Governance Systems: A Comparison of the U.S., Japan, and Europe, Oxford University Press, USA. Claudio Loderer & Kenneth Martin (1997), Executive Stock Ownership and Performance Tracking Faint Traces, Journal of Financial Economics, 45(2), Cui, H. & Mak, Y.T. (2002), The Relationship between Managerial Ownership and Firm Performance in High R&D Firms, Journal of Corporate Finance, 8(4), Demsetz, H. & Lehn, K. (1985), The Structure of Corporate Ownership: Causes and Consequences, Journal of Political Economy, 93(6), Research Paper 33

8 Indian Journal of Corporate Governance Volume 4, No.2, July-December 2011 Demsetz, H. & Villalonga, B. (2001), Ownership Structure and Corporate Performance, Journal of Corporate Finance, 7(3), Denis, D.J. & Denis, D.K. (1994), Majority Owner-managers and Organizational Efficiency, Journal of Corporate Finance, 1(1), Ganguli, S.K. & Agrawal, S. (2009), Ownership Structure and Firm Performance: An Empirical Study on Listed Mid-Cap Indian Companies, Icfai Journal of Applied Finance, 15(2), Hart, O. (1995), Corporate Governance: Some Theory and Implications, The Economic Journal, 105(430), Jensen, M.C. (1993), Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems. Journal of Finance, 48, Jensen, M.C. & Meckling, W.H. (1976), Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, Journal of Financial Economics, 3(4), Kamerschen, D.R. (1968), The Influence of Ownership and Control on Profit Rates. The American Economic Review, 58(3), Kapopoulas P & Lazaretou S, Corporate Ownership Structure and Firm Performance: Evidence from Greek Firms, Corporate Governance: An International Review, 15(2), Kumar Jayesh (2004) Does Ownership Structure Influence Firm Value? Evidence from India, The Journal of Entrepreneurial Finance & Business Ventures, 9(2). McConnell, J.J. & Servaes, H. (1995), Equity Ownership and the Two Faces of Debt, Journal of Financial Economics, 39(1), Monsen, R.J., Chiu, J.S. & Cooley, D.E. (1968), The Effect of Separation of Ownership and Control on the Performance of the Large Firm, The Quarterly Journal of Economics, 82(3), Morck, R., Shleifer, A. & Vishny, R.W., Management Ownership and Market Valuation: An Empirical Analysis, Journal of Financial Economics, 20, Myeong-Hyeon Cho, Ownership Structure, Investment, and the Corporate Value: An Empirical Analysis, Journal of Financial Economics, 47(1), Patibandla, M. (2006), Equity Pattern, Corporate Governance and Performance: A Study of India s Corporate Sector, Journal of Economic Behavior & Organization, 59(1), Praveen Bhasa, (2006), Ownership Structure and Firm Performance: A Review of Literature, ICFAI Journal of Corporate Governance, 4(4), Rajan, R.G. & Zingales, L., Which Capitalism? Lessons from the East Asian Crisis, Journal of Applied Corporate Finance, 11(3), Shleifer, A. & Vishny, R.W. (1996), A Survey of Corporate Governance, Journal of Finance, 52(2), Stulz, R. (1988), Managerial Control of Voting Rights: Financing Policies and the Market for Corporate Control, Journal of Financial Economics, 20, Welch, E., The Relationship between Ownership Structure and Performance in Listed Australian Companies, Australian Journal of Management, 28(3), Williamson, O.E., Corporate Finance and Corporate Governance, Journal of Finance, 43(3),