Most studies report ownership structure as an exogenous variable. However, Demsetz (1983) argued that ownership structure should be treated as a dependent variable. This argument was empirically modelled and confirmed by Demsetz and Lehn (1985), where they showed that the structure of corporate ownership varies systematically in ways that are consistent with value maximisation. The argument follows that greater ownership concentration results in stronger incentives to monitor and the expected gain from active monitoring and the costs of alternative ownership structures may vary across firms.
Furthermore, if transaction costs inhibiting investors from taking value maximisation positions in firms were low, as in cases of market economies such as the U.
K. , each firm would have the optimal ownership structure. In their study three main determinants of ownership structure were investigated and are briefly discussed below: Value-maximising size of the firm As firms compete both in the product and input markets successfully there is some variation in the size of the firms.
Theory suggests that the larger the firm, the greater the cost of obtaining a given fraction of ownership The increased costs (including agency costs) will cause owners of large firms to be less enthused as owners of smaller firms in achieving high levels of ownership concentration.
Control potential of the firm Demsetz and Lehn (1985) define control potential as the wealth gain achievable through more effective monitoring of managerial performance by a firm’s owners.
With control potential it is assumed that the markets for corporate control and professional management are not perfectly aligned and there is separation of ownership and control giving rise to agency costs of monitoring.
Demsetz and Lehn (1985) believe that a direct relationship exists between a firm’s control potential and the instability of the firm’s environment (or noise level) and proxy this by the variation of the firm’s profit rate (measured by both stock and accounting returns). A firm with an unstable profit rate is more than likely to be operating in a ‘noisy’ environment. As a result they suggest that the noisier the environment the greater the payoff to owners for maintaining low noise levels over managerial behaviour and the more concentrated the ownership structure.
Industries that are governed by regulation (for example the banks) are faced with certain restrictions, placing limits on the number of options available to owners. As a result there is a decline in the potential for control in ways that may not be reflected fully in profit instability.
In addition, the management of regulated firms become disciplined and can be easily monitored. In general, theory postulates that systematic regulation reduces ownership concentration. In Demsetz and Lehn (1985) empirical analysis of ownership concentration for 511 US firms, an index of ownership concentration5 was used and regressed on three alternative measures of profit instability6, the size of the firm (measured by the market value of equity) and a dummy for systematic regulation. All three measures of instability were significant and positively related to ownership concentration.
Market value of equity confirmed the expected negative relation to ownership concentration and was statistically significant at the . 95 level. The dummy for regulation too was significant, with the correct priori sign. This suggests that the average concentration of ownership for the regulated firms is significantly less than for other firms. Prowse (1992) replicated this study for Japan with the exclusion of regulation, making the necessary adjustments where the Japanese institutional or regulatory environment made it appropriate.
The empirical work found that ownership concentration in independent firms was positively related to the returns from exerting greater control over management. On the other hand, no relationship was found for keiretsu firms. As a result the open debate concerning the ‘endogenity’ problem about ownership structure and hence the direction of causality between ownership and corporate performance continues. However choice of one’s data set and researcher’s objective has been found to alleviate the problem.
Watson (1974) revealed that legal families and traditions were the main contributors to the formation of laws in different countries. Commercial laws originated from two broad perspectives: the common law (English in origin) and the civil law (Roman in origin). The civil tradition was further separated into three main families: French, German and Scandinavian. According to La Porta et al (1998), ” The differences in legal protections of investors might help to explain why firms are financed and owned so differently in different countries.
” Their literature established that corporate and other law gives investors (that is the shareholder and the creditor) certain powers or rights to protect their investments from any expropriation by insiders and as a result reduce the problem of agency costs. In addition, it was found that French -civil laws give investors the weakest legal protection, while common-law countries give both the shareholder and the creditor the strongest protection with the German and Scandinavian laws lying somewhere in the middle.
These differences cited in the legal systems determine that companies in common-law countries have better access to both debt and finance and that in civil-law countries, where investment protection is poor, ownership concentration acts as a substitute for legal protection. The UK is an example of a common-law country, and its legal origin and corporate landscape creates provides an interesting environment for analysing the relationship between ownership structure and the firm performance.
Mendez and Anson (2001) in their paper identified the legal, equity and debt financing as well as the ownership characteristics of the UK and compared them to the average characteristics of the English common-law, German-civil law and French civil-law origin (country) plus the U. S. , Germany, Japan and Spain. The UK presented higher scores of shareholder and creditor rights, rule of law and rating on accounting standards than the mean English-common law country. However when compared to the German-origin or French origin countries higher scores were reported with the exception of rule of law.
As a result measures of equity and debt financing were also higher for the UK. Statistics further indicated that the highest concentration of ownership exists in French-civil law countries (54%). German-civil law countries surprisingly reported the lowest concentration of 34%. The main contributors to this figure were the East Asian countries but the low result was however explained by the significant influence by the USA to their company law, as oppose to Germany, Austria, or Switzerland. Low results were also reported for the Scandinavian countries with 37% concentration.
The average for Common-law countries was 43% placing them in the middle range. Individually, ownership concentration for the UK was quite low, where the three largest shareholders hold 19% of the firm’s shares, compared to high scores for Germany and Spain: 48% and 51% respectively. Consequently, this fairly low concentrated value determines that the proportion of firms with no controlling shareholder, that is a shareholder whose direct and indirect voting rights in the firm exceeds 10 percent amounts to a massive 100 percent for large listed companies and 60 percent for medium listed companies.
On the other extreme, percentages for Spain were 35 for large companies and zero for medium size companies. In addition, research conducted by Faccio and Lang (2001) of the ultimate ownership and control of 5,232 corporations in 13 Western European countries at the 20% threshold, found widely held and family controlled firms most significant. 36. 93% of the firms in their sample were widely held and 44. 49% controlled by family. The U. K. headed the figures for widely held firms with 63. 08% comprising U. K. firms and reported the lowest percentage for family controlled (23. 68%).
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