Private Benefits: Ownership vs. Control

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1 Prvate Benefts: Ownershp vs. Control Bll Hu 1 Unversty of Memphs Joon Ho Hwang *2 Korea Unversty Abstract We emprcally decompose prvate benefts nto two components: benefts accrung from ownershp and benefts accrung from control. We document that prvate benefts, as measured by the block premum, ncrease slowly wth respect to the level of ownershp, as measured by the percentage of shares acqured n the block trade. On the other hand, prvate benefts ncrease rapdly wth respect to the blockholder s lkelhood of exercsng control n the company. Ths decomposton of prvate benefts allows us to quantfy nonpecunary prvate benefts by examnng the block premum when the blockholder s lkelhood of exercsng control n the company s very close to zero. EFM classfcaton : 150 JEL classfcaton : G34 1 Fogelman College of Busness and Economcs, Unversty of Memphs, Memphs, TN 38152; Tel: ; Emal: huxanku@gmal.com 2 Correspondng author : Busness School, Korea Unversty, Anam-dong, Seongbuk-Gu, Seoul , KOREA; Tel: ; Fax: ; Emal: joonhwang@korea.ac.kr

2 Prvate Benefts: Ownershp vs. Control Abstract We emprcally decompose prvate benefts nto two components: benefts accrung from ownershp and benefts accrung from control. We document that prvate benefts, as measured by the block premum, ncrease slowly wth respect to the level of ownershp, as measured by the percentage of shares acqured n the block trade. On the other hand, prvate benefts ncrease rapdly wth respect to the blockholder s lkelhood of exercsng control n the company. Ths decomposton of prvate benefts allows us to quantfy nonpecunary prvate benefts by examnng the block premum when the blockholder s lkelhood of exercsng control n the company s very close to zero. 1

3 I. Introducton The lterature defnes prvate benefts as benefts that accrue to managers or controllng shareholders, but not to mnorty shareholders. Gven the mportance of prvate benefts n the sense that many ssues n corporate governance arse from agency problems, and prvate benefts are at the heart of agency problems numerous studes have examned prvate benefts. The semnal artcles of Jensen and Mecklng (1976) and Demsetz and Lehn (1985) dscuss prvate benefts and cte both pecunary and non-pecunary prvate benefts. Later, Barclay and Holderness (1989) fnd a way to quantfy the sze of prvate benefts by usng block trade premum and reterate that prvate benefts can be pecunary or non-pecunary. 1 However, thus far, no study has come up wth a means of estmatng non-pecunary prvate benefts. Ths paper flls the gap by ntroducng a way of estmatng non-pecunary prvate benefts by decomposng prvate benefts nto an ownershp component and a control component. As a controllng party wll use corporate resources to hs or her beneft only when t s dffcult or mpossble to prove these actons n court, prvate benefts are nherently dffcult to measure. Despte these dffcultes, Barclay and Holderness (1989) fnd a means of estmatng prvate benefts usng block premum, whch s measured by the dfference between the prce per share pad for the block of common stock and the market prce of the stock followng the block transacton. The ratonale for ths measure s as follows. If all shareholders receve benefts n proporton to ther fractonal ownershp, blocks should trade at the exchange prce. However, f blockholders can enjoy benefts that do not accrue to mnorty shareholders, then blocks wll trade 1 Subsequent studes that use block premums to examne varous topcs n prvate benefts nclude Mkkelson and Regassa (1991), Ncodano and Sembenell (2004), and Dyck and Zngales (2004). La Porta, et al. (1997, 1998, 2000), Johnson, et al. (2000), Jraporn and Gleason (2007), and many other studes too numerous to menton, also examne ssues related to prvate benefts. 2

4 at a premum to the post-announcement exchange prce. 2 Usng a sample of 63 block trades durng , Barclay and Holderness (1989) fnd that the block premum averages 16 percent of the post-announcement exchange prce. As noted by Jensen and Mecklng (1976), Demsetz and Lehn (1985), and Barclay and Holderness (1989), prvate benefts can be ether pecunary or non-pecunary. Pecunary prvate benefts are prvate benefts whch can be stated n monetary terms, e.g., excessve salary or the tunnelng of the company s resources. Non-pecunary prvate benefts are prvate benefts whch cannot be stated n monetary terms, e.g., the prde of becomng a large owner, becomng part of the busness network, nteractng wth nfluental busnessmen, poltcans, and celebrtes, and enjoyng the recognton, fame, and prestge that accompany one s heghtened socal status. However, due to ther nature, non-pecunary prvate benefts can evade easy measurement. In ths study, we fnd a way to measure non-pecunary prvate benefts by notng that all pecunary prvate benefts must nvolve some control of the frm. For example, the tunnelng of the company s resources nvolves the exercse of control n the company. Therefore, we estmate the level of non-pecunary prvate benefts by examnng the sze of prvate benefts when the blockholder s lkelhood of exercsng control n company s zero (or very close to zero). Ths can be acheved f we can decompose the sources of prvate benefts nto those that stem from the exercse of control and those that stem from havng just ownershp of the company. What are prvate benefts of ownershp? Prvate benefts of ownershp are benefts that one gets by just ownng a block of shares. These benefts are somethng other than benefts from a 2 Barclay and Holderness (1989) measure the premum by usng the post-announcement prce as a benchmark because the prce that follows the block trade announcement wll ncorporate the expected change n the cash flow of the company. Therefore, the post-announcement exchange prce wll reflect the shared benefts (represented by the cash flow rghts) of the block trade, whereas the prvately negotated block trade prce wll reflect both prvate and shared benefts. Thus, the dfference between the block trade prce and the post-announcement exchange prce wll reflect only prvate benefts. 3

5 clam on future cash flows, snce cash flows accrue to all shareholders and therefore are not prvate benefts. The aforementoned examples of non-pecunary prvate benefts (e.g., the prde of becomng a large owner, becomng part of the busness network, nteractng wth busnessmen and celebrtes, and enjoyng the recognton, fame, and prestge that accompany one s heghtened socal status) do not accrue to mnorty shareholders and the blockholder can enjoy these benefts wthout the need to exert control n the company s decson makng process. Therefore, these benefts represent prvate benefts of ownershp. To decompose prvate benefts nto those arsng from ownershp and those arsng from control, we use data on block trades. Block trades are a good source of data for ths research for the followng reasons. Frst, followng Barclay and Holderness (1989), we can estmate prvate benefts by calculatng the block premum that s assocated wth a block trade. Second, we can decompose prvate benefts nto ownershp and control, because people who acqure blocks of shares are often powerful enough to exercse control n the company (Holderness and Sheehan (1988)). Blockholders, n addton to ownng dfferent portons of a company s shares, vary n terms of how much control they exercse over the frm. For example, person A, who owns 10 percent of the shares of company X, may be very actve n the frm s decson makng process, whle person B, who holds 20 percent of the shares of company Y, may be passve n exercsng control n the company. Therefore, because every blockholder s unque wth respect to hs or her ownershp level and control level, we can decompose prvate benefts nto ownershp and control. 3 Frst, wth regard to the ownershp level, we use the percentage of shares acqured n the block trade. Then, 3 It s lkely that greater ownershp wll accompany greater control of the company. However, as long as the ownershp level and control level are not perfectly correlated, t s possble to decompose prvate benefts nto ownershp and control. The example concernng persons A and B n the paragraph above llustrates ths pont. 4

6 we measure prvate benefts of ownershp by the margnal effect of the percentage of shares acqured on the block premum. Second, wth regard to measurng the control level, we estmate the lkelhood of top executve turnover wthn one year followng the block trade. Ths measure s created by frst examnng whether there was a top executve turnover wthn one year of the block transacton and then constructng an mpled probablty of top executve turnover at the tme of the block trade. The assumpton here s that the most sgnfcant control actvty that a blockholder can exercse s to replace the top executve of the company; thus, control actvtes are best reflected by change n the top executve. 4 Then, we measure prvate benefts of control by the margnal effect of the probablty of top executve turnover on the block premum. The above tasks are acheved by usng a two-stage regresson model, where both the block premum and the top executve turnover are treated as endogenous varables. We fnd that prvate benefts, as measured by the block premum, ncrease slowly wth respect to the level of ownershp but ncrease rapdly wth respect to the blockholder s lkelhood of exercsng control n the company. Interestngly, however, we fnd that even when there s very small chance of exercsng control n the company, nvestors are wllng to pay a premum to become blockholders. These non-pecunary prvate benefts range from 0.61% to 5.92% of the share prce. The proporton of non-pecunary prvate benefts to total prvate benefts ranges from 18% (for a 5% ncrease n ownershp) to 29% (for a 50% ncrease n ownershp). Ths shows that non-pecunary prvate benefts comprse a non-trval porton of total prvate benefts. We would lke to note that our emprcal method s not wthout lmtatons. 5 Frst, the use of the lkelhood of executve turnover for measurng the blockholder s expected level of control may not be perfect snce there may be other, less sgnfcant, ways of exercsng control n the 4 Holderness and Sheehan (1988) fnd that many corporate majorty shareholders place ther representatves n top management postons. 5 We would lke to thank the referee for pontng out ths lmtaton of the estmate. 5

7 company. 6 If ths s the case, our measure of ownershp level wll ncorporate resdual control actvtes that are not captured by the lkelhood of top executve turnover. Therefore, we may be underestmatng the control level, and overestmatng the ownershp level. Second, as Dyck and Zngales (2004) noted, the block premum estmate used n Barclay and Holderness (1989) can mproperly estmate prvate benefts. There s no bas n the estmate only when the block trade prce reflects the buyer s wllngness to pay (.e., the seller has all the barganng power) or when securty values (.e., the beneft from cash flow rghts) are the same for the buyer and the seller. If that s not the case, the bas becomes greater as the seller s barganng power becomes smaller. 7 However, Dyck and Zngales (2004) fnd that n countres wth lower levels of prvate benefts, the seller has greater barganng power, and that the US shows one of the lowest levels of prvate benefts. Therefore, we thnk our sample of block trades from the US s mnmally affected by the bas of the block premum measure. The rest of the paper s organzed as follows. In Secton II, we descrbe the data and descrptve statstcs. The decomposton of prvate benefts nto ownershp and control, and the measurement of non-pecunary prvate benefts are examned n Secton III. We conclude ths study n Secton IV. 6 In one of our robustness tests, we check for the lkelhood of other possble control actvtes such as board turnover, changes n captal expendture, changes n leverage, etc. However, the possble crtcsm s not fully elmnated because the above alternatve specfcatons of control actvtes stll do not represent all types of control actvtes. 7 The exact sze of the bas s α(1-λ)(y b -Y s ), where α [0,1] s the fractonal sze of the block, λ [0,1] s the barganng power of the shareholder who s sellng the block, and Y b (Y s ) s the securty value of the buyer (seller). 6

8 II. Data A. Data Formaton We collect block trade data over from the SDC Mergers and Acqustons database. Transactons must nvolve the transfer of a block of shares that comprses between 5% (nclusve) and 50% (exclusve) of the shares outstandng and must be classfed as block purchase n the acquston technque category of the SDC Mergers and Acqustons database. The lower cutoff pont of 5% s used for our dataset because t s the pont that trggers a mandatory flng to the SEC wth regard to the block transacton. The upper cutoff pont s 50% snce we want to examne how block premum changes wth regard to dfferent levels of control n the company, whereas f someone acqures 50% or more of a company s share, she wll then have ganed full control of the company. Therefore, because our sample conssts of block trades that nvolve partal control of the company, t allows us to observe cross-sectonal varatons n the levels of ownershp and control. 8 From our ntal sample sze of 1,804, there must be nformaton about the prce pad per share for the block transacton and the exchange prce one day after the announcement of the block trade. We exclude cases where the prce pad per share may not be objectvely valued, such as transactons nvolvng convertble bonds, optons, and warrants,. To rule out nstances where the transacton prce may not reflect prvate benefts, we exclude cases where ether the target or the acqurer s ether a government agency or a subsdary of the other party. We further exclude transactons that are open market repurchases, tender offers, spnoffs, recaptalzatons, self-tenders, exchange offers, repurchases, and acquston of remanng nterest. Also, to stay away from block trades that are drven by takeover motves, we rule out block trades whch happen wthn sx months before a merger or acquston that nvolves 8 Ths selecton crteron also excludes cases where the fnal shareholdng after the block trade of the new blockholder becomes 50% or more, snce these block trades wll ental full control of the company. 7

9 the block-tradng company, and block trades that are accompaned by an ndcaton of ether a takeover or a tender offer for the remanng shares, as nferred from readng the SDC synopss. Although the partes of the block transacton can be ether nsders or outsders of the company, Barclay and Holderness (1989) note that purchasers of the trade are typcally outsders and not one of the frm's drectors or offcers. For the objectve of our paper, we restrct our sample to only those block transactons where both partes are not afflated wth the company and where the block purchaser s not a current blockholder of the company. The reason behnd ths selecton crteron s that t s unclear how accurately the block premum wll reflect prvate benefts when nsders or current blockholders take part n the transacton. For example, nsders or current blockholders who purchase a block of shares may already possess sgnfcant controllng power wthn the company, n whch case they wll not pay extra for the block. Smlarly, n the case of nsders sellng a block, they may stll retan control of the frm even after the trade and thus wll not worry about losng ther prvate benefts. By focusng on new outsde purchasers, we are able to conduct a cleaner measurement of prvate benefts. We dentfy nsder ownershp and the percentage of outsders among board members of the company whose block s traded. We collect these data from the frm s proxy statement wth the most recent record-date pror to the block transacton. We search the LexsNexs Company Profles to dentfy top executve turnovers wthn one year after the block transacton. A top executve s defned as the CEO or, f a frm has no CEO, the presdent. As n prevous studes (e.g., Wesbach (1988) and Dens, et al. (1997)), we exclude from our sample those cases where top executve turnovers occur ether as part of the normal retrement process or due to death or llness. The crteron for normal retrement s that the turnover takes place between the ages of 64 and 66 for the top executve. Wth these crtera, the sze of our fnal sample s

10 B. Summary Statstcs Table 1 reports descrptve statstcs for the 738 block trades sample and for subsamples of two categores of block trades: those followed by top executve turnover wthn one year of the block transacton and those that are not followed by top executve turnover wthn one year of the block trade. [Table 1] Followng Barclay and Holderness (1989), the block premum s defned as follows. ( Prvately negotated block trade prce) ( one day after exchange prce) % Block Premum 100 one day after exchange prce...(1) The block premum averages 9.31% for the whole sample. Ths fgure s smaller than the average block premum of 16% reported by Barclay and Holderness (1989). The dfference may arse from the dfference n the sample perods: n the case of Barclay and Holderness (1989) and n ths study. Also, by usng the SDC database, we are able to construct a sample of 738 block trades whereas Barclay and Holderness (1989) searched the Wall Street Journal to dentfy 63 block trades. Whle the Wall Street Journal may report only newsworthy events, our sample ncludes block trades that are less dramatc. For block trades that are followed by top executve turnover wthn one year of the block trade, the premum averages 17.80%. However, for trades that are not followed by top executve turnover wthn one year, the premum averages only 6.92%. The dfference s sgnfcant at the 1% level. Ths dfference n the block premum ndcates that there may be benefts to havng 9

11 control over the frm, as ndcated by the change n the top executve, over and above the benefts of just ownng a block of shares of the frm. Also, more shares of the company (15.37% vs %) are acqured for block trades that result n subsequent top executve turnover. Ths mples that the acqurer s more lkely to exercse control n the frm as she holds more shares of the frm. Table 1 also dsplays that on average, nsders control 7.83% of the frm s shares n our sample. Insder ownershp ncludes shares owned by ndvduals related to a member of the top management team, employee penson or stock opton plans, trusts for whch managers have some votng authorty, and any other blocks of shares over whch a member of the top management team has votng authorty. By way of comparson, Morck, et al. (1988) report that the average ownershp of all offcers and drectors s 10.6% n a sample of 371 Fortune 500 frms and Mkkelson and Partch (1989) report an average nsder ownershp of 19.6% n a random sample of New York and Amercan Stock Exchange frms. Our sample frms therefore have smaller nsder ownershp. Ths s consstent wth Bethel et al. (1998), who fnd that companes wth hgh nsder ownershp are less lkely to experence block share purchases. The low nsder ownershp of our sample mples that block trades of 5% or more shares of the company can confer sgnfcant amount of controllng power to the new blockholder. Consstent wth prevous studes (e.g., Mkkelson and Partch (1989) and Dens, et al. (1997)), frms that experence top executve turnover have worse performance. However, wth respect to nsder ownershp, the fracton of frms wth outsder-domnated boards, and the fracton of frms where the top executve s a member of the foundng famly, we do not fnd sgnfcant dfferences between frms wth top executve turnover and frms wthout top executve turnover wthn one year of the block trade. 10

12 III. Results on Prvate Benefts A. Determnants of Block Premum Table 2 shows the results of a cross-sectonal regresson of block premums usng the followng model. Block premum = α + β1 percentage of shares acqured) + β2 top executve turnover dummy) + β3 pror frm performce) + β4 log( frm sze) + β5 leverage) + β6 tangblty of assets) + β7 ndvdual acqurer dummy) + β8 acqurer s n the same ndustry dummy) + β9 bank acqurer dummy) + β j ndustry dummes) + βh year dummes).(2) Possble factors that can affect the premum can be categorzed nto the ownershp level of the company, whether the block trade s actually assocated wth control actvtes wthn the frm, and control varables whch capture characterstcs of the block-traded company and of the acqurer. [Table 2] A larger fractonal ownershp gves the blockholder more power n terms of havng greater votng rghts. Larger ownershp also provdes greater protecton from a hostle takeover or proxy contest. Beyond a certan pont, however, few addtonal prvate benefts wll result from ncreased fractonal ownershp f the blockholder holds a suffcent amount of shares. There are also costs to ownng a large porton of shares, such as montorng costs or the costs that ensue from a possble lack of dversfcaton n the owner s portfolo. Ths means that blockholders may not want to accumulate shares beyond a certan threshold. If the threshold vares by frm, there may be no dscernble relatonshp between fractonal ownershp and block premum. Barclay and 11

13 Holderness (1989) and Dyck and Zngales (2004) show a postve relatonshp between block premum and the sze of shares acqured. The results n Table 2 confrm that the block premum tends to be greater as the fractonal sze of the block ncreases. 9 To examne how the sze of prvate benefts s related to an actual control actvty as manfested though top executve replacement, we examne cases of top executve turnover wthn one year after the announcement of the block trade. 10 In the regresson, we nclude a dummy varable for block trades that are followed by a top executve turnover wthn one year of the announcement of the block trade. The results show that block premums are ndeed larger for trades that are followed by change n the top executve. The expected block premum goes up by 7.86% for block trades that are followed by top executve turnover n the frm wthn one year of the block trade. Assumng that block premums for trades that are followed by top executve turnover reflect prvate benefts of havng control of the company n addton to prvate benefts of ownershp, the results suggest that there are prvate benefts from havng control of the frm (as reflected by the coeffcent of the top executve turnover varable) over and above the benefts from havng just the ownershp of the frm (as reflected by the coeffcent of the percentage of shares acqured varable). We use the followng control varables to capture the characterstcs of the block- traded company. Frst, the sze of prvate benefts wll be greater f the frm s performng well and smaller f the frm s havng fnancal dffcultes (Barclay and Holderness (1989)). We measure the pror year s market-adjusted stock return usng the percentage of common stock return for the 12 months endng two months before the block trade announcement mnus the return on the 9 When we nclude the square term of the percentage of shares acqured, ts coeffcent s not sgnfcant at the conventonal level. 10 Holderness and Sheehan (1988) show that for trades of majorty blocks of stock, 71% of block trades nvolve turnovers among the three top managers wthn one year of the trade and conclude that many large shareholders place ther representatves n top management postons. 12

14 CRSP equal-weghted ndex. 11 Second, frm sze may affect the block premum. On one hand, block premum may ncrease wth frm sze because larger frms offer potentally greater benefts, both pecunary and non-pecunary (Barclay and Holderness (1989)). On the other hand, the costs of beng a blockholder may also ncrease wth frm sze, as larger frms are more lkely to be montored closely by securty analysts, government offcals, and nsttutonal nvestors. We measure frm sze as the natural logarthm of the frm s book value of total assets. 12 Thrd, the sze of debt may affect the block premum. However, a pror relatonshp between prvate benefts and debt s not clear. Debt can have a negatve effect on prvate benefts by constranng access to free cash flow (Jensen (1986)). In contrast, debt can also ncrease one s effectve control over corporate assets (Harrs and Ravv (1988) and Stulz (1988)), thereby ncreasng the sze of prvate benefts. Fourth, prvate benefts may also be related to the tangblty of assets because acqurers of the block can face more dffculty n dvertng resources f assets are ted down and easly observable. Fnally, prvate benefts may also dffer across ndustres. Demsetz and Lehn (1985) suggest that owners of companes n the meda, entertanment, and sports ndustres enjoy greater prvate benefts. We capture ndustry dfferences by categorzng companes whose blocks are traded nto ther major ndustry groups based on the two-dgt SIC code. Manufacturng (wheren the two dgts of the SIC code le n the range of 20-39) s the most common ndustry group and s the excluded category n our regresson. We also use the followng control varables, whch capture the characterstcs of the acqurer. Frst, we nclude a dummy varable for acquston by ndvduals because ndvduals, compared to corporate blockholders, have the added beneft of consumng perqustes (Demsetz and Lehn (1985)). Second, n the case where the acqurer s a corporaton rather than an 11 We also use the CRSP value-weghted ndex as an alternatve benchmark. The results are smlar. 12 The results do not change f we measure frm sze by the frm s market value of equty plus book value of debt. 13

15 ndvdual, there may be more prvate benefts for the acqurer to enjoy f the acqurng company s n the same ndustry as the target company. Thus, we nclude a dummy varable that takes a value of one when the acqurng company s n the same ndustry group as the target company based on the two-dgt SIC code. Fnally, f the acqurer s a fnancal company, t may acqure shares manly for fnancal reasons and not for the consumpton of prvate benefts. Thus, we nclude a dummy varable that takes the value of one when the acqurer s a fnancal company. The results n Table 2 show that the block premum s margnally larger for frms that have better pror performance. As for the tangblty of assets, whereas Dyck and Zngales (2004) fnd an nsgnfcant relatonshp between block premum and the tangblty of assets n ther nternatonal study, we fnd a negatve and sgnfcant relatonshp (at the 10% level) between block premum and the tangblty of assets. As for dfferent ndustres of the block-traded companes, only the retal trade ndustry group dummy turns out to be a sgnfcant factor of block premum. 13 B. Determnants of Top Executve Turnover A possble shortcomng of the approach used n the prevous secton s the endogenety of top executve turnover. Ths s because whether or not the top executve wll be replaced after the block trade s not an event that s known wth certanty at the tme of the block trade. Hence, the acqurer of the block cannot be certan whether the top executve wll be replaced soon after the block trade. Rather, the new blockholder can only guess the lkelhood of top executve turnover. Ths lkelhood of top executve turnover wll be dfferent for each block trade because crcumstances surroundng the block trade wll be unque for each block trade. These 13 When we nstead assgn a dummy varable for frms n the meda, entertanment, and sports ndustres, whose frst two dgts of the SIC code are 27, 48, 78, 79 or the frst three dgts s 731, the dummy varable remans nsgnfcant. 14

16 crcumstances wll be a functon of varous factors, such as pror frm performance, ownershp structure, and board characterstcs, whch have been shown n prevous lterature to affect the lkelhood of top executve turnover. Certan crcumstances surroundng a block trade may ndcate greater lkelhood of top executve turnover than for other block trades. Under those stuatons where the current top executve poston s at rsk at the tme of the block trade, the acqurer may be wllng to pay more for a block of shares n antcpaton of exercsng control n the company. Thus, n ths secton, we estmate the mpled probablty of the blockholder s exercsng control of the frm, as manfested by the lkelhood of top executve turnover, at the tme of the block trade. Later, n Secton 3.C, we measure how the block premum changes wth respect to ths mpled probablty of top executve turnover. We estmate logt regressons relatng the probablty of top executve turnover to frm performance, ownershp characterstcs, and board composton. Model 1 s the basc model whereas Model 2 ncludes nteracton terms between pror frm performance and ownershp structure/board composton varables that have been shown n prevous lterature to nfluence the lkelhood of management turnover. MODEL 1 : Top executve turnover dummy = α + β1 percentage of shares acqured) + β 2 pror frm performce) + β3 nsder ownershp) + β 4 outsder domnated board dummy) + β5 top exec. s foundng famly dummy) + β6 log( frm sze) MODEL 2 : Top executve turnover dummy = α + β1 percentage of shares acqured) + β 2 pror frm performce) + β3 dummy for 5% < ( nsder ownershp) < 25%) + β 4 dummy for ( nsder ownershp) > 25%) + β5 outsder domnated board dummy) + β6 top exec. s foundng famly dummy) + β7 log( frm sze) + β8 pror frm performce) dummy for 5% < ( nsder ownershp) < 25%) + β9 pror frm performce) dummy for ( nsder ownershp) > 25%) + β10 pror frm performce) outsder domnated board dummy)...(3) 15

17 [Table 3] The explanatons for some of the ndependent varables are as follows. Frst, we nclude the percentage of shares acqured n the block trade because a blockholder who owns a greater proporton of a frm s shares has more votng power n the company and has more ncentve to work towards value-ncreasng actvtes such as replacng ncompetent CEOs. Second, we nclude the nsder ownershp varable because more manageral shareholdngs may better algn the nterests of managers and shareholders, and provde managers wth a greater ncentve to nvest n value-ncreasng actvtes (Jensen and Mecklng (1976), DeAngelo and DeAngelo (1985)). However, greater nsde shareholdngs can also entrench management by makng t more dffcult to transfer control and remove a manager (Stulz (1988), Mkkelson and Partch (1989), Dens, et al. (1997)). Thrd, we nclude the outsder-domnated board dummy because studes suggest that nternal montorng s mproved by havng a hgher fracton of outsde drectors (Wesbach (1988), Byrd and Hckman (1991), and Brckley et al. (1994)). Followng the classfcaton used by Dens, et al. (1997) and Wesbach (1988), we categorze a board as outsder-domnated f at least 60% of the company s board members are outsders. 14 Fnally, we nclude the foundng famly dummy because accordng to Morck et al. (1988), the manager s status as the founder of the frm may be conducve to manageral entrenchment, and Dens, et al. (1997) emprcally show that the top executve s less lkely to be replaced f he or she s a member of the foundng famly. The results of logt regressons are provded n Table 3. Numbers n the table refer to margnal effects where dervatves are evaluated at mean values of the varables. The margnal effects reported n Table 3 wll change accordngly as the values of some ndependent varables 14 A drector s an outsde drector when he or she s not an employee of the company, has no famly connecton wth the management of the company, and has no busness dealngs wth the company. 16

18 change n our subsequent analyses. The results n Table 3 are mostly consstent wth prevous emprcal studes on top executve turnover. The lkelhood of top executve turnover s postvely related to the block sze 15 and negatvely related to pror frm performance, nsder ownershp, and the company-founder dummy. We also fnd that an outsder-domnated board alone does not affect the lkelhood of top-management turnover, whch s consstent wth the results of Wesbach (1988) and Dens, et al. (1997). In Model 2 of Table 3, we consder the possble effects of nsder ownershp and the exstence of outsder-domnated boards on the senstvty of top executve turnover to performance. Followng A and Norton (2003) and Powers (2005), the coeffcents of nteracton terms and the tests for the statstcal sgnfcance thereof are based on the cross-partal dervatve of the expected value of the dependent varable, after allowng for the nonlnearty of the model. Dens, et al. (1997) fnd a weaker relatonshp between performance and turnover n frms wth hgh nsder ownershp. Also, the exstence of an outsder-domnated board s found to have a sgnfcant nfluence on the senstvty of turnover to performance by Wesbach (1988), whereas t s shown to be nsgnfcant by Dens, et al. (1997). We follow Dens, et al. (1997) and Morck et al. (1998) and classfy frms nto three categores of manageral ownershp: at most 5%, between 5% and 25%, and greater than 25%. The results of Model 2 n Table 3 show that frms wth nsder ownershp that exceeds 25% have 55% less probablty of top-management turnover. The results also show that nsder ownershp has a sgnfcant mpact on the senstvty of turnover to performance. The probablty of turnover s negatvely related to performance when nsder ownershp s less than 5%. 15 In our sample, 17% of block trades nvolve the largest blocks at these frms. If we nclude a dummy varable for block trades that represent the largest blocks of the company, along wth the block sze varable, the coeffcent for the dummy varable s not statstcally sgnfcant. If we nclude the dummy varable but not the block sze varable, the coeffcent for the dummy varable s margnally sgnfcant at the 10% level. 17

19 However, the postve coeffcent (0.009) on the nteracton of the pror performance varable wth the dummy varable denotng an nsder ownershp between 5% and 25% ndcates that the probablty of turnover s sgnfcantly less senstve to performance for frms n ths ownershp structure category. In fact, for frms wth nsder ownershp between 5% and 25%, the lkelhood of top executve turnover s almost unaffected by the past performance of the company ( = ). Ths s consstent wth the fndng of Dens, et al. (1997). Surprsngly, we fnd that frms wth outsder-domnated boards manfest less senstvty of top-management turnover to performance. Ths result s contrary to that of Wesbach (1988), who fnds a stronger assocaton between pror performance and the probablty of top executve turnover for companes wth outsder-domnated boards. The dfference may occur because our sample frms are confned to companes whose blocks are traded. And durng tmes of possble control contest, an exstng nsder of the company may not contnue to be algned wth the ncumbent managers. Insders may push towards replacng the top executve when opportuntes arse (n ths case, the entry of a new blockholder coupled wth poor frm performance) for ganng control of the company or beng a part of the team that gans control. Thus, for blocktraded companes, t s possble to observe greater senstvty of top-management turnover to performance for companes wth nsder-domnated boards, whch s equvalent to observng less senstvty of top-management turnover to performance for companes wth outsder-domnated boards. C. Two-Stage Regresson After computng the lkelhood of top executve turnover at the tme of the block trade, we now measure how the block premum changes wth respect to ths mpled probablty of top executve turnover. We run a recursve equaton model where the frst equaton has a 18

20 dchotomous endogenous varable (top executve turnover) and the second equaton has a contnuous endogenous varable (block premum). The basc model s stated below. Frst stage Equaton Top executve turnover dummy( T/ O) = α + β1 percentage of shares acqured) + β 2 pror frm performce) + β3 nsder ownershp) + β 4 outsder domnated board dummy) + β5 top exec. s foundng famly dummy) + β6 log( frm sze) Second stage Equaton Block premum = α + β1 percentage of shares acqured) + β 2 T/ O) β3 pror frm performce) + β 4 log( frm sze) + β5 leverage) + β6 tangblty of assets) + β7 ndvdual acqurer dummy) + β8 acqurer s n the same ndustry dummy) + β9 ( bank acqurer dummy) + β j ndustry dummes) + : : β h year dummes)...(4) The results for the two-stage regresson of block premum are shown n Table 4. Ths s the man regresson n ths study. Model 1, the basc model, ncludes the probablty of top executve turnover varable (T/O1) from Model 1 of Table 3 as an explanatory varable. Model 2 ncludes the probablty of top executve varable (T/O2) from Model 2 of Table 3 as an explanatory varable. [Table 4] The results n Table 4 show that both the percentage of shares acqured and the probablty of top-management turnover sgnfcantly affect the block premum. The postve coeffcent of the percentage of shares acqured mples there are prvate benefts from havng ownershp of the frm. Accordng to Model 1, ownng 20% more shares of the frm ncreases the 19

21 block premum by approxmately 2.6%. The postve coeffcent of the probablty of top executve turnover varable ndcates there are prvate benefts from havng control of the company over and above prvate benefts that arse from just ownng the company. In a hypothetcal case of gong from havng no lkelhood of top executve turnover wthn a year of the block trade to havng 100% chance of top executve turnover wthn a year of the trade, the block premum jumps by more than 9%. The relatonshp between pror frm performance and block premum becomes statstcally nsgnfcant n the two-stage regresson model. In our model, pror frm performance nfluences the block premum n two ways. The frst s an ndrect way through the lkelhood of top executve turnover varable. Better-performng frms are less lkely to replace ther top executve as shown n the frst-stage equaton n (4), the results of whch are shown n Table 3. Ths lower lkelhood of top executve turnover wll result n a smaller block premum n the second-stage equaton n (4). Second, n a drect way, better-performng frms are assocated wth larger block premums because blockholders antcpate enjoyng more prvate benefts from better-performng frms after controllng for the lkelhood of top executve turnover. Therefore, we fnd that pror frm performance, after explanng the lkelhood of top executve turnover n the frst-stage equaton, has a statstcally nsgnfcant nfluence on block premum n the secondstage equaton. The coeffcent of the tangblty of assets varable s sgnfcantly negatve, as n Table 2. Therefore, blockholders seem to antcpate havng more prvate benefts from companes that have a hgher proporton of ntangble assets. The results for other control varables are mostly smlar to those n Table 2. The dfference from Table 2 s the coeffcent of the ndvdual acqurer dummy varable. In Table 2, we fnd that ndvdual acqurers are assocated wth smaller, albet not statstcally sgnfcant, block premums. The result for the better-specfed model n Table 4 shows that the coeffcent of the ndvdual acqurer dummy s now postve and sgnfcant at the 10% level. Ths s consstent wth Holderness and Sheehan (1988), who fnd that 20

22 block premums are larger for ndvduals than they are for corporatons. Ths also supports the argument of Demsetz and Lehn (1985) that ndvduals, compared to corporate blockholders, have the added beneft of beng able to consume perqustes. In Models 3 and 4, we nclude the nteracton term between the percentage of shares acqured and the probablty of top executve turnover. Model 3 uses the probablty of top executve turnover as defned by Model 1 of Table 3, and Model 4 uses the probablty of top executve turnover as defned by Model 2 of Table 3. The nteracton term between the percentage of shares acqured and the probablty of top executve turnover s sgnfcant at the 10% level n Model 3 and sgnfcant at the 5% level n Model 4. Ths suggests that prvate benefts from havng ownershp and control renforce each other. The results for other varables are smlar to those n Models 1 and 2. In Model 5, we nclude square terms for the probablty of top executve turnover and the percentage of shares acqured. The square term of the probablty of top executve turnover s statstcally sgnfcant at the 5% level whereas the square term of the percentage of shares acqured s not sgnfcant. Thus, the block premum ncreases at an ncreasng rate wth respect to the mpled probablty of top executve turnover. However, block premum does not ncrease at an ncreasng rate wth respect to the fracton of shares acqured. Ths suggests that prvate benefts ncrease at an ncreasng rate as the new blockholder s more lkely to exercse control over the frm, but ncrease only at a constant rate as the blockholder s ownershp level rses. Fgure I captures the essence of ths paper. It shows a three-dmensonal plot depctng the relatonshp among block premum, block sze, and the probablty of top executve turnover. On the bass of Model 5 of Table 4, we calculate the expected values of the block premum for dfferent values of the block sze and the probablty of top executve turnover wthn a year of the block transacton. Except for the block sze varable, all rght hand sde varables n the frst-stage regressons of Equaton (4) that explan the probablty of executve turnover are chosen so that they le wthn the same standard devaton from ther respectve means. For all other varables n 21

23 the second-stage regresson of Equaton (4) for estmatng the block premum gven a certan block sze and probablty of executve turnover, we use ther mean values. [Fgure I] As can be seen n the graph, prvate benefts, as measured by the block premum, ncrease slowly wth respect to the ownershp level, as measured by the percentage of shares acqured, and ncrease rapdly wth respect to the lkelhood of exercsng control, as measured by the probablty of top executve turnover wthn a year of the block trade. We show numercal examples n Table For a ten-percent block trade, the expected block premum s: 1.20% f there s a 0% lkelhood of subsequent top executve turnover; 5.75% f there s a 25% lkelhood of subsequent top executve turnover; and 12.80% f there s a 55% lkelhood of subsequent top executve turnover. However, for a 25% block trade, the expected block premum s: 2.38% f there s a 0% percent lkelhood of subsequent top executve turnover; 9.68% f there s a 25% lkelhood of subsequent top executve turnover; and 19.48% f there s a 55% lkelhood of subsequent top executve turnover. Thus, the block premum ncreases at an ncreasng rate wth respect to the probablty of top executve turnover, holdng everythng else constant. However, wth respect to the percentage of shares acqured, the block premum ncreases at a constant rate, holdng everythng else constant. For example, for block trades that have a 25% 16 The numbers n Table 5 are out-of-sample estmates of block premums for a gven block sze and probablty of executve turnover. Even when the block sze s less than 50% of the frm s shares, other varables can cause the probablty of executve turnover to be 100%, as can be seen from the frst-stage regresson of Equaton (4) and Table 3. 22

24 probablty of top executve turnover, the expected block premum s: 5.75% for a block trade wth a block sze of 10%; 9.68% for a block sze of 25%; and 13.61% for a block sze of 30%. [Table 5] Table 5 also gves us a measure of non-pecunary prvate benefts. For the blockholder to enjoy pecunary prvate benefts, they need to have some control over the frm s actvtes. For example, pecunary benefts such as recevng excessve salary or tunnelng through self-dealng transactons all requre exercsng control n the company. On the other hand, blockholders can enjoy non-pecunary prvate benefts even wthout exercsng any control n the company. For example, the feelng of beng a proud owner of a company, becomng part of the busness network, nteractng wth nfluental and well-known busnessmen, poltcans, and celebrtes, achevng hgher socal status, and enjoyng the recognton, fame, and prestge that accompany the hgher socal status, can be acheved wthout exercsng control. Therefore, the block premum when the lkelhood of top executve turnover s zero (or very close to zero) can be used to estmate the non-pecunary prvate benefts. The results n Table 5 show that even when there s lttle chance of exercsng control n the company, some nvestors are wllng to pay a premum to be a blockholder. It s at ths extreme where the blockholder has very lttle chance of exercsng control n the company that we measure the non-pecunary prvate benefts. In our sample, nonpecunary prvate benefts range from 0.61% (for a block trade of 5% of the frm s shares) to 5.92% (for a block trade of 50% of the frm s shares) of the share prce. The fracton of nonpecunary benefts out of the total prvate benefts ranges from 18% (for a block trade of 5% of the frm s shares) to 29% (for a block trade of 50% of the frm s shares) when total prvate benefts are computed at the mean values of the varables. Ths shows us that although non- 23

25 pecunary prvate benefts are smaller n sze than pecunary prvate benefts, non-pecunary prvate benefts consttute a non-trval porton of the total prvate benefts. 17 As one must be qute wealthy to purchase a block of shares, we thnk that becomng a large owner of a company s another way of pursung the lfestyles of the rch and famous and that consderable non-pecunary benefts must be embedded n the premum these blockholders pay to acqure blocks of shares. The reason blocks are traded at a premum even when there are only prvate benefts of ownershp or non-pecunary benefts may have resemblance to why people pay an extraordnary prce to acqure a pece of art or a wne collecton. 18 D. Robustness Tests D1. Subsample of Postve Block Premums Some blocks of shares are traded at a dscount rather than at a premum. Ths s because the ownershp of a block of shares not only brngs benefts, but also costs, such as montorng costs, nventory costs, and the costs of possbly carryng an undversfed portfolo. If these costs outwegh the benefts, block trades wll occur at a dscount. Therefore, t should be noted that the block premum s a net-beneft measure of prvate benefts. However, to avod the possble ambguty of nterpretng negatve net prvate benefts, we examne f our results hold for the subsample of block trades wth postve block premums. Ths subsample, as was shown n Table 1, conssts of 514 block trades, or 69.65% of our entre sample. We repeat the same test procedures for the subsample of block trades that occur at a postve premum. The results reported n Panel A of Table 6 are smlar to those n Table 5, 17 One may argue that the blockholder has both pecunary and non-pecunary prvate benefts, when she has control of the company. In ths case, our measure of non-pecunary prvate benefts when the control level s zero may represent a lower bound of the true sze of non-pecunary prvate benefts. Ths strengthens our fndng that non-pecunary prvate benefts comprse a szable amount relatve to the total prvate benefts. 18 See Rachman (1999) for the evdence on the prces of wne. 24

26 whch reports the results for the whole sample of block trades. 19 Thus, our results are robust to whether block trades occur at a premum or a dscount. [Table 6] D2. Other Control Actvtes Although replacng the top executve s the most sgnfcant manfestaton of a control actvty, there can be other ways n whch the blockholder can exert nfluence n the frm. Thus, besdes examnng only the changes n the top executve poston, we check how expected changes n board members, nvestment polcy (captal expendture and R&D), and fnancal polcy (leverage and dvdend payout) affect the sze of prvate benefts. Panel B of Table 6 shows the results of alternatve specfcatons for the recursve regresson model of estmatng the block premum. The effect of the lkelhood of board turnover on the block premum s examned n Model 1. Usng a smlar methodology that was used to explan top executve turnover, the probablty of board turnover s the mpled probablty of board turnover at the tme of the block trade and s created from the frst-stage logt regresson where the explanatory varables are pror frm performance, percentage of shares acqured, log of frm sze, nsder ownershp, and outsder-domnated board dummy. The results show that the expected lkelhood of board turnover s not a statstcally sgnfcant factor of the block premum. The effects of the expected changes n captal expendture and R&D on the block premum are shown n Models 2 and 3, respectvely. The change n captal expendture varable s the mpled change n captal expendture at the tme of the block trade and s created from the frst-stage logt regresson where the explanatory varables, followng Bertrand and Schoar (2003), are cash flow, Tobn s Q, and the log of frm sze. The change n R&D varable s 19 For brevty, n Table 6, we only report coeffcents of nterest. Full results are avalable upon request. 25

27 constructed n the same way. The results show that the expected change n captal expendture postvely affects the sze of the block premum, whereas the expected change n R&D s not a sgnfcant determnant of the block premum. Under the stuaton where captal expendture s expected to ncrease by 100%, the block premum ncreases by 1.7%. Ths mples that ncreased captal expendture, such as nvestng n pet projects, may be one way through whch prvate benefts are realzed. The effects of the expected changes n leverage and dvdend payout rato are shown n Models 4 and 5, respectvely. The change n leverage s the mpled change n leverage at the tme of the block trade and s created from the frst-stage logt regresson where the explanatory varables, followng Bertrand and Schoar (2003), are cash flow, ROA, and the log of frm sze. The change n the dvdend payout rato s constructed n the same way. The results show that both measures of fnancal polcy are not sgnfcant determnants of the block premum. To summarze, when we measure prvate benefts that result from addtonal control actvtes, the change n captal expendture s the only varable that sgnfcantly affects the block premum. Ths suggests that captal expendture may be one channel where the block owner can extract prvate benefts from the company. However, the lkelhood of ncreasng captal expendture seems to have much smaller economc sgnfcance than the lkelhood of top executve turnover. A 50% ncrease n the expected captal expendture ncreases the block premum by only 0.85%, whereas a 50% ncrease n the lkelhood of top executve turnover ncreases the block premum by 4.6% Another thng to note s that the goodness-of-ft of the model under alternatve control actvty s much lower than the goodness-of-ft of the model usng top executve turnover, whch was shown n Table 4. 26

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