Blockholder Heterogeneity, Monitoring and Firm Performance
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1 Blockholder Heterogeneity, Monitoring and Firm Performance Christopher Clifford University of Kentucky Laura Lindsey Arizona State University December 2008
2 Blockholders as Monitors Separation of Ownership and control in public firms may lead to agency conflict between the firm s managers and owners Berle and s (1932), Jensen and Meckling (1976) Shareholders may monitor firm management to reduce this agency conflict, but there is a free-rider problem Grossman and Hart (1980) Large blockholders may be able to mitigate the free-rider problem Shleifer and Vishny (1986) Conflicting Evidence in Literature on Efficacy of Blockholders as Monitors December
3 Empirical Evidence on Monitoring Most evidence indicates that shareholder activism can prompt small changes in target firms governance structures, but has negligible impacts on share values and earnings. (Karpoff, 2001) Corporate Raiders Holderness and Sheehan (1985); Bethel, Liebeskind, and Opler (1998) Corporations Mikkelson and Ruback (1985); Allen and Phillips (2000) Pension Funds and Shareholder Groups Karpoff, Malatesta, and Walkling (1996); Wahal (1996); Del Guercio and Hawkins (1999); Opler and Sokobin (1995); Strickland, Wiles, and Zenner (1996); Barber (2006) Mutual Funds Parrino, Sias, and Starks (2003); Davis and Kim (2006) Hedge Funds Brav, Jiang, Partnoy, and Thomas (2008); Klein and Zur (2008); Clifford (2008) But blockholder organizations may themselves incur agency costs December
4 Our Approach Examine differences in operating (& stock price) performance for firms with different types of outside blockholders Include a variety of blockholder types Group by compensation associated with organizational form Active (13-D) and Passive Filings (13-G) Control for selection with econometric techniques to identify causal effects What we find: An outside blockholder has no effect on performance, but activist and high-incentive blockholders improve firm performance! December
5 Data S&P 1500 from 1996 to 2005 Hand-collected blockholdings from proxy statements following Dlugosz, et al. (2005) A blockholder is an investor who holds more than 5% of the company s equity Excluded insider blocks Categorized each blockholder by organizational form (e.g., other industrial corporation, mutual fund, hedge fund) Collected filing information on active (13D) versus passive holding (13G) Other sources: CRSP, Compustat, Execucomp, IRRC, IBES December
6 Distribution of Blockholder Types Organizational Form Number of Firm- Years 13-D / Active Filers 13-D / Active Filers (%) No Outside Block 1, Outside Block 9,166 1, % Corporation % Financial Institutions 3, % Mutual Fund / Inv. Advisor 7, % Pension % Professional Investor % Venture Capital % Private Equity % Hedge Fund % Low Incentive 12, % High Incentive 2, % High Incentive = Professional Investor, Venture Capital, Private Equity, Hedge Funds, (Corporations) December
7 Distribution of Blockholder Freq. Number of Blocks All Outside Blocks 15.5% 22.6% 25.6% 18.2% 11.0% 7.1% Active Blocks 85.4% 12.8% 1.5% 0.2% 0.1% 0.0% High Incentive Blocks 81.7% 14.7% 2.7% 0.7% 0.2% 0.0% High Incentive = Professional Investor, Venture Capital, Private Equity, Hedge Funds, (Corporations) December
8 Open Questions Does the presence of an outside blockholder, activist blockholder, or high-incentive blockholder matter for firm performance? Controlling for firm characteristics Controlling for endogeneity (self-selection) of blockholder presence How do these effects relate to other monitoring mechanisms? Firm Governance: Entrenchment and Anti-takeover Indices Market Following: Analyst Coverage December
9 Empirical Details Blockholders may select firms likely to outperform Empirical technique of Instrumental Variables controls for endogeneity of blockholder presence IV approach requires something correlated with the presence of 5% Blockholder (and Active or High Incentive Blockholders) but uncorrelated with performance residual Measures from 13-F filings: Institutional ownership, Average institution s ownership share Stock Liquidity Measures: Turnover, Bid-ask Spread Basic Specification: ROA t+1 -ROA t-1 = f(block t,, Active or High Incentive t, X t ) Block t = f(instruments, X t ) Active or High Incentive Block t = f(instruments, X t ) Errors: White (1981, clustered by firm) December
10 Variables of Interest and Controls Blockholder Variables Indicator for Outside 5% Blockholder Indicator for Active Blockholder (13-D filer) Indicator for High Incentive Blockholder Performance measures Change in industry-adjusted (FF30 median) ROA Long run abnormal stock returns (size and book to market adjusted) Company characteristics Firm Size (MV of Assets) Exec options characteristics R&D expenditures/ Assets Year Indicators Age (years public) (Lagged ROA) Book Leverage/ Assets Governance Indices Officer&Director Ownership Analyst Coverage December
11 Effects on Operating Performance ROA improves with the presence of High-Incentive Blocks and Activist Blocks... (controls) HAS OUTSIDE BLOCK HAS HIGH INCENTIVE BLOCK HAS ACTIVE BLOCK ROA ROA HAS OUTSIDE BLOCK N/A N/A N/A *** (-2.80) -81 (-0.29) HIGHINCENTIVE N/A N/A N/A *** N/A (5.06) N/A N/A N/A N/A *** (4.65) *** *** N/A N/A (1.61) (5.42) (4.40) *** ** N/A N/A (10.34) (0.55) (-2.12) *** N/A N/A (-3.18) (-0.45) (-0.36) (1.30) * (1.86) (1.10) N/A N/A Number of observations Hansen J Prob > Chi-sq Kleibergen-Paap rk LM Prob > Chi-sq F (20,1274), (18, 1274) Prob > F December
12 Effects on Long-Run Returns Also true for long-run abnormal returns LR ABNORMAL RETURNS (OLS) LR ABNORMAL RETURNS (OLS) LR ABNORMAL RETURNS (IV-GMM) LR ABNORMAL RETURNS (IV-GMM) HAS OUTSIDE BLOCK *** (3.92) *** (3.92) *** (-2.57) (-0.25) HIGHINCENTIVE N/A *** N/A (1.57) (5.25) N/A (1.29) N/A *** (4.37)... (controls) Number of observations Hansen J Prob > Chi-sq Kleibergen-Paap rk LM Prob > Chi-sq F (18,1335), (18, 1269) Prob > F December
13 Cumulative Abnormal Returns around filing dates Filing Type N CAR (-1,0) CAR (-1,+1) CAR (-1,30) CAR (-2,2) CAR (-5,5) CAR (-10,10) Active (13D) %*** 1.55%*** 3.62%*** 2.46%*** 3.72%*** 6.09%*** Passive (13G) Š no batches % 0.14% 0.19% 0.30% 0.26% -0.08% High Incentive Š no batches %*** 1.52%*** 4.41%*** 2.12%*** 3.50%*** 4.72%*** Low Incentive Š no batches % % -0.42% 0.19% -0.05% 0.39% after filing dates Filing Type N CAR (+1,2) CAR (+1,5) CAR (+1,30) CAR (+1,90) CAR (+1,125) CAR (+1,250) Active (13D) %* 1.67%** 2.23% 4.82% 7.33%** 18.70%*** Passive (13G) Š no batches % 0.18% 0.12% 1.10% 0.36% -1.64% High Incentive Š no batches %** 1.87%*** 3.17%*** 5.31%** 5.33%** 14.25%*** Low Incentive Š no batches % -0.05% -0.41% 0.51% 0.14% -2.71% December
14 How? As in hedge fund results, no evidence that performance comes through cash flow disciplining measures Unlike hedge fund results, no clear reduction in assets Ź Std. N Diff. Error. p-val N Diff. Ź CASH Passive Low Std. Error. p-val Active High PAYOUT Passive Low Active High LEVERAGE Passive Low Active High ASSETS Passive Low Active 1, High INVESTMENT Passive Low Active High December
15 Monitoring and Governance Do activist and high incentive blockholder effects relate to corporate governance in the firm? Can effective blockholder monitors substitute for good corporate governance? Add governance index to performance equation (as endogenous variable) Anti-takeover, Entrenchment, GIM Interact governance index with active and high-incentive blockholder measures Interaction term treated as exogenous December
16 Governance Index Interactions Efficacy of Activist (and High Incentive Blocks) are increasing in quality of governance ROA (ENTRENCH) HAS OUTSIDE BLOCK -60 (-0.16) HIGHINCENTIVE *** (2.83) ROA (ENTRENCH) ROA (EXTERNAL) ROA (EXTERNAL) (0.25) * (-1.73) (-1.32) N/A *** N/A (2.85) N/A ** N/A *** (2.44) (2.80) (-0.90) (-0.12) (-0.21) (0.68) ** ** *** *** (-2.54) (-2.25) (-2.62) (-2.61)... (controls) Number of observations Hansen J Prob > Chi-sq Kleibergen-Paap rk LM Prob > Chi-sq F (20,1144) Prob > F December
17 Monitoring and Market Attention Do activist and high incentive blockholder effects relate to other market monitoring mechanisms? Can effective blockholder monitors substitute for market monitoring? Add analyst coverage index to performance equation (as endogenous variable) Construct terciles of low to high analyst coverage Interact analyst coverage with active and high-incentive blockholder measures Interaction term treated as exogenous December
18 Analyst Coverage Interactions Efficacy of Activist (and High Incentive Blocks) are decreasing in market following ROA ROA HAS OUTSIDE BLOCK (-1.15) (-1.26) HIGHINCENTIVE ** N/A (2.36) N/A *** (3.07) (1.28) (1.09) ** (-2.31) *** (-3.02)... (controls) Number of observations Hansen J Prob > Chi-sq Kleibergen-Paap rk LM Prob > Chi-sq F (20,1268) Prob > F December
19 Note on Incentives Organizational forms differ by features other than use of carry Liquidity requirements Use of leverage Results not similar segmenting blockholder types based on clientele liquidity demands Results are similar segmenting blockholder types based on use of leverage, but also hold for low-leverage, high-carry blocks Work in progress Examining intra-organizational compensation characteristics (e.g., use of performance fees among mutual funds and investment advisors) Positive relation between the likelihood of pursuing activism and performance-based compensation December
20 Conclusions Open question as to what types of shareholders are effective as monitors and when they are most effective We find, intuitively, that incentives matter: there is a relation between incentive compensation and (a) efficacy as blockholder monitor and (b) likelihood to pursue activist strategies Intentions (filing choice) also accurately reveals type Not purely a hedge fund effect All regression results are robust to the exclusion of hedge funds from activist and high incentive blocks Activist Strategies are credible Performance improvements greater in well-governed firms (Activism complements good governance) Performance improvements greater in undiscovered firms (Activism may substitute for a market following) December
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