The evolution of ownership structures in publicly traded firms:
Evidence from controlling family ownership exits
Sandy Klasa∗
Lundquist College of Business
1208 University of Oregon
Eugene, OR 97403-1208
541.346.1341
541.346.3341 (Fax)
[email protected]
This Draft: January 2002
Abstract:
I examine what leads controlling families of publicly traded firms to sell their remaining ownership stake. I
find that this exit is best explained in the context of theories of the firm relating to the CEO succession
process, optimal risk-bearing, and the separation of ownership and management expertise. I show that a
timing explanation is only marginally supported. Finally, I do not find that this exit is explained by familycontrolled firms having insufficient financial resources to fully invest in growth opportunities. My study
fills a gap in our knowledge about what causes controlling owners that have already taken their firms public
to exit from their remaining ownership. In doing so, it adds to our understanding of the evolution of
ownership structures from private entrepreneurial firms to public, widely-held corporations. Finally, my
findings also help to identify costs of concentrated ownership.
∗
I thank Jeff Brookman, Larry Dann, Craig Rennie, and participants at the 2001 FMA Doctoral Student
Seminar for helpful comments and suggestions. I am especially grateful to my dissertation committee
members, Jarrad Harford (Chair), Wayne Mikkelson, Megan Partch, and James Ziliak for their comments
and advice.
1
1.0
Introduction
Zingales (1995) and Mello and Parsons (1998) model the determination of
ownership structure over a firm’s development. They show that when entrepreneurs take
their firms public, it is likely to be the first of several stages in the sale of the firm to
outsiders. Mikkelson, Partch, and Shah (1997) and Brennan and Franks (1997) examine
the evolution of ownership structures at the time of an initial public offering and the years
immediately subsequent to this offering. However, scant empirical evidence exists
concerning how ownership structures evolve beyond this stage in a firm’s development.1
This results in an important gap in our knowledge about what causes controlling owners
of seasoned companies to exit from their remaining ownership.
I examine what leads controlling owners of publicly traded firms to sell their
remaining ownership stake. I study 81 closely held publicly traded firms in the United
States that were controlled and managed by individual families who sold their remaining
ownership stake during the years 1984-1998. These transactions occurred when
controlling families accepted a bidder’s offer for either all of the outstanding equity of the
firm or for only the family’s controlling block. I determine the empirical relevance of
three types of explanations for why such controlling owners exited from their ownership.
First, elements of theories of the firm can explain this exit. For instance, Fama
and Jensen (1983) contend that the riskier is a firm, the greater are costs that are incurred
if a small number of residual claimants bear most of the firm’s residual risk. Also, they
argue that the more complex are firm operations the less efficient it is if decision agents
1
One exception is Denis and Sarin (1999) who examine ownership structure changes for a large sample of
firms over a ten-year period.
2
that initiate and implement important decisions also monitor these decisions. Hence, an
increase in firm risk or in the complexity of firm operations increases the likelihood that a
controlling family exits from its ownership. Additionally, studies such as Parino (1997)
and Berry, Bizjak, Lemmon, and Naveen (2000) show that CEO retirement often results
in significant succession costs. Thus, in order to avoid such costs, a controlling family
could sell its ownership block in anticipation of the retirement of the controlling family
top officer. Finally, Zingales (1995), Hubbard and Palia (1995), and Bebchuk (1999)
argue that owners who enjoy large private benefits of control are less likely to sell their
ownership stakes since they want to retain these benefits. However, Shleifer and Vishny
(1986) show that outside blockholders monitor managerial behavior and this reduces
managerial perquisite consumption. Hence, the presence of outside blockholders
increases the likelihood that a controlling family exits from its ownership.
Second, timing a sale to exploit overvaluation can explain this exit. That is, a
controlling family attempts to sell its shares in the firm when their market value exceeds
the family’s privately informed valuation. This explanation is motivated by the Ritter
(1991) argument that owners attempt to sell overvalued equity by timing equity sales to
coincide with peaks in “industry specific fads” and the empirical support for this
contention provided by Lerner (1994) and Pagano, Panetta, and Zingales (1998). This
explanation is also motivated by the empirical findings of Degeorge and Zeckhauser
(1993), Jain and Kini (1994), and Mikkelson, Partch, and Shah (1997) that owners are
likely to time initial equity offerings to take advantage of mispricing resulting from the
firm reaching a peak in its operating performance.
3
Third, a demand for financial slack can explain ownership exits. That is, real
wealth gains are created if a financially constrained family-controlled firm is sold to an
acquirer that has the financial resources to fully invest in the firm’s growth opportunities.
Such gains are created if the firm has valuable investment opportunities, but also has a
lack of internally generated funds and raising funds externally is costly. This explanation
is consistent with Myers and Majluf (1984) who argue in the context of their model that
“a merger always creates value if one firm’s surplus slack covers the other’s deficiency”
(p.217).
In order to determine the empirical relevance of my three explanations for
controlling family ownership exits, I compare my sample firms to a group of matched
family-controlled firms with families that do not exit from their ownership. My findings
support theory of the firm explanations for why a controlling family exits from its
ownership. However, my results only provide minimal support for the timing explanation
and no support for the financial slack explanation for this exit. The only support I find for
the timing explanation is limited evidence that a controlling family exits because of
market overoptimism concerning investment opportunities in the firm’s industry.
I show that controlling families are likely to exit in order to avoid succession costs
when there are no qualified family members to replace a controlling family chairman
who is near retirement. Specifically, I find that when older chairmen have no other
controlling family members among the top three executives of the firm, there is an
increased likelihood that a controlling family exits from its ownership.
Additionally, I document that the likelihood of an exit is positively associated
with the size of the firm. This supports arguments made by Demsetz and Lehn (1985) that
4
because of risk aversion, owners of large firms with concentrated ownership only agree to
purchase additional shares at lower, risk-compensating prices. Consequently, the
resulting increased cost of capital discourages the continued use of concentrated
ownership structures in large firms.
I also test the Fama and Jensen (1983) hypothesis that the more complex are firm
operations the higher are costs from sacrificing the benefits of a specialization of decision
functions. I find that an exit is more likely the greater is the number of business segments
in which the firm operates. This suggests that controlling families of firms with more
complex operations exit because of inefficiencies created if in such firms the same agents
that initiate and implement important decisions also monitor these decisions.
As well, my results show that the likelihood that a controlling family exits is
positively associated with the level of outside block ownership in a firm. Moreover, the
results of exogeneity tests indicate that causality is likely to run from the level of outside
block ownership to the probability that a controlling family exits. This suggests that
monitoring provided by outside blockholders is useful even in family-controlled firms
and that this monitoring increases the likelihood that a controlling family exits from its
ownership.
Finally, I do not find any evidence that the probability that a controlling family
exits from its ownership is smaller if this family enjoys larger private benefits of control.
Likewise, I show that the existence of constraints on a controlling family’s ability to
expropriate wealth from minority shareholders, such as cumulative voting or
compensation or audit subcommittees on which controlling family members do not sit,
does not increase the probability that a family exits. These results are inconsistent with
5
predictions made by Zingales (1995), Hubbard and Palia (1995), and Bebchuk (1999) that
the higher are private benefits of control the less likely are controlling owners to exit
from their ownership.
My study contributes in two ways. First, it fills a void in our knowledge about
what causes controlling owners of publicly traded firms to proceed to subsequent stages
of the sale of the firm to outside parties. In doing so, it increases understanding about the
process in which private entrepreneurial firms evolve into widely held, public firms. I
show that the exit of controlling owners of public firms from their remaining ownership
stake in the firm is best explained by theories of the firm having to do with the CEO
succession process, optimal risk-bearing, and the separation of ownership and
management expertise.
Second, the results of my study help to answer the broader question of whether
costs of concentrated ownership are significant. Shleifer and Vishny (1997), in their
recent survey of the corporate governance literature, argue that there is a lack of
persuasive evidence to answer this question. Yet, this question begs to be answered given
the evidence from studies such as La Porta, Lopez-De-Silanes, and Shleifer (1999) and
Holderness, Kroszner, and Sheehan (1999) that concentrated ownership structures are
prevalent in most countries and that even in the United States such structures are not
uncommon.
My findings suggest that in large firms with concentrated ownership, significant
costs can arise because of the excessive amount of risk borne by the firm’s principal
owners. Additionally, the evidence from my study shows that costs of concentrated
ownership could be important if a firm has complex operations and it is run by its
6
principal owners. Finally, my results concerning private benefits of control indicate that,
at least for the United States, costs resulting from controlling owners representing their
own interests and expropriating wealth from minority shareholders may not be that large.
This is consistent with the Barclay and Holderness (1992) finding that in the United
States there is little evidence of substantial wealth expropriation on the part of large
corporate blockholders. It is equally consistent with arguments made in La Porta, LopezDe-Silanes, and Shleifer (1999) and La Porta, Lopez-De-Silanes, Shleifer, and Vishny
(2000) that as a result of the superior legal protection of minority shareholders in the
United States, it is difficult for controlling owners of American firms to expropriate
wealth from non-controlling shareholders.
The remainder of this paper is organized as follows. Section 2 develops
hypotheses and describes variables used to test these hypotheses. Section 3 discusses
sample selection. Section 4 presents and interprets empirical findings. Lastly, section 5
concludes.
2.0
Hypothesis development
In this section I develop hypotheses related to my three explanations for why
controlling families exit from their ownership. These hypotheses predict whether a firm is
more likely to be one in which a controlling family exits from its ownership or a firm
from a matched sample consisting of family-controlled firms with controlling families
that do not undertake such exit strategies. I note that both groups of families have a
family member who is the chairman of the firm. Finally, from this point onwards, I refer
7
to a ‘controlling family’ as a ‘family’ since all families that I discuss are controlling
families.
2.1
Hypotheses based on theories of the firm
I test six hypotheses related to four different theories of the firm for why a family
exits from its ownership. These theories are related to the CEO succession process,
agency costs, optimal risk-bearing, and the separation of ownership and management
expertise.
2.1.1
A family exits from its ownership in order to avoid high succession costs.
Parino (1997) and Berry, Bizjak, Lemmon, and Naveen (2000) show that
succession costs are often significant because it is difficult for a firm to find an executive
who has the necessary human capital to succeed a departing CEO. Additionally,
Anderson and Reeb (2001) show that family-owned firms with a family member CEO
outperform family-owned firms that are run by an outsider. This suggests that succession
costs in family-controlled firms are important when there is no qualified family member
to replace a controlling family chairman. Hence, it is possible that if the controlling
family chairman is close to retirement age, the family sells its controlling block in the
firm to an outside party that wishes to gain control of the firm’s operations.
I first test this hypothesis by examining whether the likelihood that a family exits
from its ownership is positively associated with the age of the controlling family
chairman. Next, I verify whether this likelihood is positively associated with a dummy
variable for whether the controlling family chairman is aged 64 years or older and there
8
are no other family members among the three highest paid executives of the firm.2 This
variable captures both the likelihood that a controlling family chairman is close to
retirement and that there could be a lack of qualified family members to succeed this
individual at the helm of the firm. Vancil (1987) shows that when insiders succeed the
CEO, the most common succession process involves a relay in which an heir apparent,
such as the president or the chief operating officer of the firm, is groomed to succeed the
CEO for several years before the incumbent CEO actually steps down. Hence, a finding
that prior to the exit of a family there are no other family members among the three
highest paid executives of the firm is consistent with the idea that there is a lack of
qualified family members worth grooming to succeed the controlling family chairman.
2.1.2
The likelihood that a family exits from its ownership is negatively associated with
the magnitude of the private benefits of control enjoyed by this family.
Holderness and Sheehan (1988) explain that private benefits of control could take
the form of large-block shareholders paying themselves excessive salaries, investing in
negative-net-present-value projects, or withdrawing corporate funds. Zingales (1995),
Hubbard and Palia (1995) and Bebchuk (1999) contend that owners are unlikely to sell
their ownership stakes if they enjoy large private benefits of control. Similarly, I expect
that families that enjoy large private benefits of control are less likely to exit from their
ownership.
I use several proxy variables for the likelihood that a family enjoys large private
benefits of control. My first variable is wealth expropriation via excess cash
2
Brickley, Linck, and Coles (1999) point out that CEOs that depart their firms and presumably retire are
concentrated among CEOs aged 64 to 66.
9
compensation for the controlling family chairman.3 I do not include option-based
compensation in my analysis since prior to 1993 most proxy statements have incomplete
information concerning option grants. Moreover, omitting option-based compensation
may not be that problematic for my sample firms since Bates, Jandik, and Lehn (2000),
who examine executive compensation in family-controlled firms, find that such firms rely
significantly less on stock options as a form of executive compensation than do firms that
are not controlled by a family.
I calculate excess compensation using the methodology outlined in Walkling and
Long (1984). I regress the pre-exit year cash compensation of the chairman of each
sample and matched firm on market value of equity and return on assets. Excess
compensation for the chairman of each firm is then measured as the residual from this
regression for each firm.4 Finally, I also verify and report whether my results are
different if I use alternate specifications to calculate excess cash compensation.
As well, I examine whether the likelihood that a family exits is negatively
associated with a family-controlled firm having dual class stock. This is motivated by the
Grossman and Hart (1988) argument that managers of firms with multiple classes of
3
It could be argued that a family might be more likely to expropriate wealth by paying itself a special
dividend. However, it is difficult, if not impossible, to determine from financial statements what parts of
the amounts of total special dividends paid out are received by different classes of shareholders. Hence, it
would be problematic to measure wealth expropriation by the family via the payment to this family of
special dividends. Additionally, since the family incurs additional costs due to the double taxation of
dividends if it pays itself such a dividend, tax effects should make a family less likely to expropriate wealth
by paying itself a special dividend. Thus, due to these two factors, I only consider wealth expropriation via
excess compensation for the controlling family chairman.
4
I note that Core, Holthausen and Larcker (1999) use a different method to calculate excess compensation.
They regress compensation on firm characteristics and internal governance variables and use the
coefficients on the internal governance variables to predict excess compensation. I argue that their measure
of excess compensation is not appropriate for my study because by study design my sample and matched
sample firms have similar governance characteristics since these firms are all run by a family.
10
shares are more likely to expropriate wealth from minority shareholders and their
contention that if a firm with dual class stock is controlled by a family then “presumably
in such cases the family receives significant private benefits from control” (p.200).5
Additionally, I investigate whether a family that exits from its ownership is more
likely to be constrained in its ability to expropriate wealth from minority shareholders.
Holderness and Sheehan (1998) contend that managers or corporate investors who own a
large amount of their firm’s common stock may have constraints on their ability to
expropriate wealth from non-controlling shareholders. They state that such constraints
could include cumulative voting for electing directors or the existence of board
subcommittees such as audit or compensation subcommittees on which large block
shareholders do not sit. Finally, they explain that since Big Six accounting firms have the
greatest reputational capital to lose if information about a low-quality audit is exposed,
these accounting firms will offer higher quality audits and more protection for minority
shareholders.
Thus, based on the arguments in Holderness and Sheehan (1998), I examine
whether firms with families that exit are more likely to use cumulative voting to elect
directors, to have audit or compensation board subcommittees on which family members
do not sit, or to have an auditor who is from a Big Six accounting firm.
5
Moreover, the evidence from studies such as Lease, McConnell, and Mikkelson (1983,1984), DeAngelo
and DeAngelo (1985), and Zingales (1995b) that shares with superior voting rights trade at a premium are
consistent with the idea that the holders of these shares receive control benefits that holders of ordinary
shares do not. However, it can be noted that Partch (1987) finds that shareholder wealth is not affected by
the creation of a class of stock with different voting rights. Hence, this result is inconsistent with the idea
that dual class stock structures lead to higher private benefits of control for managers via wealth
expropriation from minority shareholders.
11
Finally, I also investigate whether families that exit are more likely to enjoy
smaller non-pecuniary private benefits of control. Demsetz and Lehn (1985) argue that
managers of mass media firms could enjoy non-pecuniary private benefits of control if
they believe they can influence public opinion through their firm. Also, they contend that
managers could enjoy non-pecuniary private benefits of control if their firm owns a
professional sports team. For instance, managers could enjoy controlling such a team and
having this team win a major sports championship. Hence, I determine whether the
probability that a family exits is negatively associated with a dummy variable for whether
the firm or one of its subsidiaries owns a professional sports team, newspaper, magazine,
television or radio station, or produces movies or television shows.
2.1.3
A family is more likely to exit from its ownership the greater is the percentage of
the firm owned by outside blockholders.
Shleifer and Vishny (1986) contend that the presence of outside blockholders
helps to monitor management and in some cases even results in an ousting of
management through a proxy fight or takeover. Shivdasani (1993) finds results consistent
with this by showing that large outside shareholders increase the likelihood that a firm is
taken over. While it is likely that the influence of outside blockholders is smaller in a
firm controlled and managed by an individual family, this influence could still help to
protect minority shareholder interests. For instance, DeAngelo and DeAngelo (2000)
show that for the family-controlled Times Mirror Company, the monitoring provided by
outside shareholders helped to curb controlling family perquisite consumption. Hence,
the influence of outside blockholders could result in a family enjoying smaller private
benefits of control and in the family being more open to the idea of exiting from its
12
ownership. Thus, I test whether the percentage of equity owned by outside blockholders
is positively associated with the likelihood that a family exits.
However, one potential problem with examining this association is that if a
significant association is found it will not be certain whether this is the result of causality
running from the presence of outside blockholders to a family pursuing an exit strategy.
Instead, it could be hypothesized that such an association exists because outside investors
are more likely to invest in a firm controlled by a family that enjoys smaller private
benefits of control and that is consequently more receptive to the idea of relinquishing its
control of the firm. Hence, if I find that outside block ownership is positively related to
the probability that a family exits, I will need to test for the direction of causality.
2.1.4
A family is more likely to exit from its ownership subsequent to an increase in the
firm’s equity risk.
Fama and Jensen (1983) argue that although restricting residual claims to decision
agents helps to reduce owner-manager conflicts of interest, such a restriction may be
inefficient because it sacrifices the benefits of unrestricted risk sharing. For instance, a
manager with too much undiversified wealth tied up in the firm could make inefficient
investment decisions due to the lack of diversification of his personal wealth. I anticipate
that the greater the diversification benefits resulting from a family exiting from its
ownership, the more likely will be this family to exit. Also, I expect that these
diversification benefits will be more important the greater is the equity risk of the firm. I
test whether a family exits due to increased equity risk by examining whether during the
eighteen months prior to the first announcement of the transaction leading to the exit of
13
the family, an increase in the standard deviation of average monthly stock returns in a
firm’s industry is associated with a larger likelihood that a family exits.
I note that I could alternatively measure whether the change in a firm’s own
standard deviation of monthly stock returns during this period is associated with the
likelihood that a family exits. However, such an approach is problematic because it is
possible that information concerning the likelihood of a family’s exit is received by
market participants prior to the first press release of the transaction leading to this exit.
Such information is likely to increase stock price volatility and this could lead to a bias in
favor of finding that individual firm stock price volatility increases prior to the exit of a
family. Nevertheless, I replicate this test using firm specific data and report my findings.
Finally, I point out that the age of a controlling family chairman is likely to affect
his risk tolerance. For instance, a younger chairman could have a higher risk tolerance
and be less likely to exit from his ownership in the firm subsequent to an increase in firm
risk. Hence, in univariate tests this omitted variable may make it difficult to test whether
an increase in firm risk is associated with the exit of a family. However, a multivariate
test, that controls for the age of the controlling family chairman provides a cleaner test of
this hypothesis.
2.1.5
A family is more likely to exit from its ownership the larger is the market value of
the firm’s equity.
Demsetz and Lehn (1985) explain that the larger is a firm the greater is the need
for a small group of owners to commit additional wealth to meet the capital needs of this
firm. Also, they point out that due to risk aversion these owners will only purchase
additional shares at lower, risk-compensating prices. Hence, they contend that larger
14
firms will suffer from higher overall costs of capital if ownership is concentrated and that
this discourages owners of such firms from maintaining concentrated ownership.
Similarly, I hypothesize the likelihood that a family exits is positively associated with the
market value of the firm’s equity. Finally, I note that in making this hypothesis, I
implicitly assume that the greater is the market value of a family-controlled firm’s equity,
the larger is the fraction of the total wealth of a controlling family that is invested in the
firm.
2.1.6
A family is more likely to exit from its ownership if the firm has more
complex operations.
Fama and Jensen (1983) contend that in firms with complex operations, costs
resulting from sacrificing the benefits of a specialization of decision functions are higher.
This occurs since in such firms diffusion of the initiation, implementation, and
monitoring of decisions is beneficial as it permits for a delegation of decisions to agents
with valuable relevant knowledge. This diffusion in decision functions typically also
results in a separation of the initiation and implementation of decisions from the
monitoring of these decisions. Along the same lines, I expect that the more complex are
the operations of a firm, the more likely is a family that both controls and manages this
firm to exit from its ownership. In my test of this hypothesis, I use the number of
business segments in which the firm operates as my proxy variable for the complexity of
firm operations.
15
2.2
Hypotheses related to the timing explanation
2.2.1
A family exits from its ownership to exploit favorable market conditions.
Ritter (1991) suggests that managers time equity sales with peaks in market
overoptimism concerning prospects in the firm’s industry. Zingales (1995) argues that
owners are more likely to pursue an exit strategy when such opportunities to sell
overvalued equity arise. IPO studies provide support for the contentions made in these
two studies by showing that firms are more likely to go public when sectoral stock prices
are higher. For instance, Lerner (1994) finds that the decision by venture capitalists to
take biotechnology firms public is positively related to the performance of the
biotechnology sector stock market index. Along the same lines, Pagano, Panetta, and
Zingales (1998) show that the likelihood of a firm having an IPO is positively associated
with the median value for the market-to-book ratio of assets in a firm’s industry.
Moreover, they show that investment for IPO firms decreases subsequent to the offering.
Hence, they claim the positive association they find is not the result of higher investment
needs in sectors with greater investment opportunities, but rather this association is the
result of market timing. In order to determine if controlling family ownership exits are
the result of market timing, I examine whether the likelihood of an exit is positively
associated with the change in the median market-to-book ratio of assets in a firm’s
industry during the two years prior to the exit of a family.6 Finally, I also investigate if
this likelihood is associated with the median pre-exit year market-to-book ratio of assets
in a firm’s industry.
6
I also replicate this test using firm specific data and report my findings.
16
2.2.2
A family is more likely to exit from its ownership subsequent to an improvement
in operating performance.
The evidence from IPO studies such Degeorge and Zeckhauser (1993), Jain and
Kini (1994), and Mikkelson, Partch and Shah (1997) that initial equity offerings are
usually timed to follow a year during which operating performance improves suggests
that owners attempt to sell their shares when they can take advantage of mispricing.
Along the same lines, it is possible that families exit from their ownership subsequent to a
year of superior operating performance. Hence, I test whether the change in operating
performance during the pre-exit year is positively associated with the likelihood that a
family exits from its ownership.
2.3
Hypothesis related to the financial slack explanation
2.3.1
A family is more likely to exit from its ownership if the firm has valuable growth
opportunities but it is deficient in financial slack.
Mello and Parsons (1998) explain that an owner could exit if the firm is sold to a
“better positioned party” (p.84). I hypothesize that a family exits if this results in the
creation of real wealth gains due to the acquirer of the firm being better positioned to
fully invest in the firm’s investment opportunities. This occurs if a firm controlled by an
individual family operates in an industry with substantial investment opportunities, but
this family cannot invest in these because of a lack of internally generated funds and an
inability to raise funds externally. The inability to raise funds externally could be the
result of asymmetric information problems such as those discussed in Myers and Majluf
(1984). Additionally, if the family does not wish to dilute its ownership this could also
make it difficult to raise funds externally. Under the latter scenario, a family might prefer
17
to sell its controlling block in the firm rather than dilute its ownership by having a
seasoned equity offering.
Under either of these scenarios, if an acquirer has access to the financial resources
needed to invest more fully in the firm’s growth opportunities, the acquisition of the firm
by this acquirer leads to a creation in real value. This is consistent with Myers and Majluf
(1984) who argue that real wealth gains are created if an acquirer’s excess slack covers
the target firm’s deficiency in slack.
I investigate whether the likelihood that a family exits from its ownership is
positively associated with a dummy variable that measures if there are significant growth
opportunities in the firm’s industry and the firm has a lack of financial slack. To
determine whether growth opportunities in the firm’s industry are unusually high, I
examine whether the value for the firm’s pre-exit year median industry market-to-book
ratio of assets is above that of the median sample and matched firm. Similarly, to verify if
a firm is deficient in financial slack, I examine whether during this same year industryadjusted net working capital standardized by total assets for a firm is below that of the
median sample and matched firm. Finally, I also perform the same test except that to
determine whether the firm is deficient in financial slack, I examine whether a firm’s
two-year change in net working capital standardized by total assets prior to the exit year
is smaller (more negative) than that of the median sample and matched firm.
18
3.0
Sample selection
My principal sample consists of 81 publicly traded firms in the United States that
are controlled and managed by individual families that exit from their ownership in the
firm during the years 1984-1998. In 62 of these cases a family exits by accepting a
bidder’s offer for all of the outstanding equity of the firm. In the remaining 19 instances a
family accepts a bidder’s offer for only the family’s controlling block. The median
amount of time between a firm’s initial public offering and the exit of a family from its
remaining ownership is fifteen years. For purposes of comparison, it can be noted that
Mikkelson, Partch and Shah (1997) examine ownership changes during the ten years
subsequent to initial public offerings while Brennan and Franks (1997) look at ownership
changes for up to seven years after such offerings. Hence, I study exits that, on average,
take place subsequent to those examined in Mikkelson, Partch, and Shah (1997) and
Brennan and Franks (1997).
Sample firms are initially identified using the SDC (Securities Data Company)
database FAM function, which identifies whether acquisitions take place that involve
target firms controlled by an individual family that owns at least twenty percent of the
equity of the firm and has a family member who is the chairman of the firm. My sample
period runs from 1984-1998 since prior to this period SDC does not reliably code firms
with the FAM flag.
My criteria for a firm to be family-controlled are similar to those used in recent
ownership structure studies such as La Porta, Lopez-De-Silanes and Shleifer (1999).
These studies define a firm as family-controlled if a family or individual directly or
indirectly controls at least twenty percent of the votes of the firm. The families I examine
19
also control twenty percent of the votes of the firm. Additionally, to ensure that these
families have important economic interests in the firm, I require that they directly own at
least twenty percent of the cash flow rights of the firm.7
In order to be included in my sample, I verify with proxy statements that prior to
the exit the voting and cash flow rights of the family are at least twenty percent. Since it
is difficult to compare accounting data between financial and non-financial firms, I also
require that sample firms not operate in financial industries (SIC codes from 6000-6999).
Additionally, I exclude firms that do not have data on Compustat. My final sample
consists of 81 firms with families that exit from their ownership.
I create a matched sample by matching a firm controlled by a family that does not
exit from its ownership to each sample firm. The matched sample enables me to compare
firms whose families exit from their ownership with firms whose families do not take
such strategies. Firms in the matched sample are controlled by an individual family that
owns at least twenty percent of the voting and cash flow rights of the firm and that has a
family member who is chairman. I also require that each firm matched to a sample firm
not have its family exit from its ownership during the two years subsequent to the exit of
the family of the sample firm to which it is matched. Data for each matched firm are
collected from the same year as they are for the sample firm to which the firm is matched.
In order to create my matched sample I use CDA Investment Technologies’
Spectrum publications to initially identify firms that have individuals who own at least
twenty percent of the equity of the firm. Subsequently, I use Standard and Poor’s
7
This latter requirement results in the elimination of one firm that has dual class stock and four firms that
do not have dual class stock, but in which the family has high voting rights as a result of controlling the
voting rights of equity that it does not own, such as stock owned by charitable foundations.
20
Register of Corporations, Directors and Executives to determine whether these
individuals are the chairmen of their firms. Next, I verify that matched firms have data on
Compustat and that I can find proxy statements for these firms. Finally, I examine proxy
statements dated at least two years after the date of the exit of the family of the sample
firm to which each firm is matched to ensure that the families of the matched firms do not
exit from their ownership.8
Table 2 presents the distribution of sample and matched sample firms over the
study’s sample period. The table shows that the majority of families exit from their
ownership during the period from the middle through the end of the 1980s. This
coincides with a period during which increased mergers and acquisitions activity takes
place. Mitchell and Mulherin (1996) argue that this increased activity was the result of
restructuring within industries that underwent economic shocks. Hence, in tests of the
empirical relevance of my three explanations for why families exit from their ownership,
I investigate whether economic shocks within particular industries could be underlying
causes of these exits.
Finally, it may be useful to briefly discuss my research approach that involves
making treatment-control comparisons. A potential problem with my treatment sample is
that firms are not randomly chosen. Hence, in order to reduce or even eliminate biases
that this creates, matches are constructed on the basis of observable characteristics of
8
My procedure to identify matched firms consists of alphabetically counting forward fifty firms from my
sample firm in the Spectrum publication and then identifying the first firm that has an individual who owns
at least twenty percent of the equity of the firm. (I do this counting routine because if I simply select the
next firm that appears alphabetically after my sample firm this could introduce a non-random factor in my
selection process if the next firm shares the same first word in its name as the sample firm and this biases
the firm toward operating in the same industry as the sample firm.) I then verify that the firm meets all of
the other requirements mentioned above. If the firm doesn’t meet one of these requirements, I search for the
next firm in alphabetical order in the Spectrum Publication that does meet all the necessary requirements.
21
firms in the treatment sample. However, it is problematic to match on too many
conditioning variables because it is difficult to meet all of the requirements that these
variables impose on the researcher. Consequently, matching on too large a number of
such variables leads to methods that are dependent on the use of arbitrary sorting schemes
that create a hierarchy in matching variables.9
I contend that by matching on whether a firm is family-controlled and the
chairman of the firm is a member of the controlling family, I am able to reduce much of
the bias resulting from my treatment sample not being randomly chosen. Since each firm
matched to one of my treatment firms is also run by a controlling family that owns a
minimum of 20 percent of the cash flow and voting rights of the firm and I collect data
for each of these firms from the same year as I do for treatment firms, it can be argued
that matched firms are quite comparable to treatment firms. I note that I do not match on
additional characteristics such as the size of the treatment firm or the industry in which it
operates since in some of my tests the size of the treatment firm or the performance of
this firm’s same industry counterparts are used as explanatory variables for why a family
exits from its ownership. Hence, if I matched on size and industry I could no longer
conduct these tests. Finally, another important reason why I do not match on the size or
industry of a treatment firm is that given data constraints it would be difficult if not
impossible to find matches for every firm in the treatment sample if I used such
conditioning variables.
9
See Heckman, Ichimura, and Todd (1998).
22
4.0
Empirical findings
4.1
Industry breakdown of sample and matched firms
Table 3 provides information on the industry breakdown of sample and matched
firms. It is useful to consider the findings in this table in order to evaluate whether it is
likely that restructuring activities within particular industries could be a major cause of
the ownership exits I study. For instance, evidence that ownership exits are clustered
within particular industries or that sample and matched firms are found to significantly
differ with respect to the industries in which they operate could suggest that the exits I
examine are the result of industry restructuring. Table 3 documents that there is little
evidence that sample and matched firms are clustered within particular industries.
Instead, both sample and matched firms operate in a wide variety of industries. Also, this
table shows that sample and matched firms differ only minimally with respect to the
industries in which they operate.10 Hence, it does not seem that the ownership exits I
study can be explained in the context of restructuring activities within particular
industries.
4.2
Univariate findings
Table 4, Panel A provides evidence on governance variables that are not directly
used to test hypotheses but that are useful to consider in interpreting the results of tests of
the study’s hypotheses. This panel shows that the median percentage of cash flow rights
10
The instruments and related products industry is the only industry in which one of the two groups of
firms has a noticeably larger number of firms that operate in a particular industry than does the other group
of firms. Specifically, I find that eight matched firms operate in the instruments and related products
industry, but that only one sample firm operates in this industry.
23
owned by the family is about 40 percent for both sample and matched firms.
Additionally, Panel A documents that the median number of years of service of the
chairman of both groups of firms is substantial. For both sets of firms the median value is
approximately 20 years. Finally, Panel A also shows that for both groups of firms about
half of the directors on the board are inside directors and that a greater percentage of
inside directors are controlling family inside directors than non-controlling family inside
directors.
The similarities between governance variables for the two groups of firms suggest
that differences that I find between sample and matched firms for variables used to test
my hypotheses are not the result of the families in my two groups of firms being
fundamentally different from one another. For instance, I am not comparing families that
own most of the equity of the firm and have yet to exit from much of their ownership
with families that have already exited from all of their ownership except what is needed
to retain control of the firm. Hence, the families in both groups of firms have sold similar
levels of the firm to outsiders. Thus, findings that I document regarding whether the
study’s hypotheses are supported are unlikely to be the result of families in the two
groups of firms behaving in different manners because prior to the exit year they are at
markedly different stages of the sale of the firm to outsiders. Similarly, the fact that the
median chairmen in both groups of firms have long tenures with their firm suggests that
the families of these two groups of firms have controlled their firms for significant
periods. Hence, differences in family behaviors or in firm characteristics are not due to
comparing families that have a relatively short history running their firm with families
that have controlled their firm for an extensive period.
24
Table 4, Panel B provides information concerning the pre-exit year financial
characteristics of sample and matched firms. This panel shows that the two groups of
firms do not differ significantly with respect to their degree of financial leverage,
profitability, or the size of their investment opportunities. However, this panel documents
that both sample and matched firms are less leveraged than are the median firms in their
industries. Although I do not tabulate the significance of this result, I find that these
differences in financial leverage are significant at the one and five percent levels for
sample and matched firms, respectively. The finding that both sample and matched firms
are significantly less leveraged than are their same industry counterparts is consistent
with that of other studies that examine the association between leverage and whether a
firm is family-controlled. For instance, Agrawal and Nagarajan (1990) show that firms
having extensive family relationships among top management are likely to avoid
leverage. My finding also supports the contention made by Agrawal and Nagarajan
(1990) that controlling families avoid leverage in order to reduce the risk of their
undiversified portfolio invested in the firm.
Table 5 provides results of tests of theory of the firm hypotheses related to the
CEO succession process and agency costs. This table shows that the median age of the
chairman of a firm whose family exits is 63 years while the median age of this individual
for a firm whose family does not exit is 56 years. The difference between the two ages is
significant at the one percent level. Table 5 also documents that the proportion of firms
that have both a controlling family chairman who is 64 years or older and no other
controlling family members among the top three executives of the firm is significantly
greater for sample than for matched firms. This proportion is 27 percent for firms with
25
families that exit and 12 percent for firms with families that do not exit. These results
support the idea that a family exits if the controlling family chairman is closer to
retirement age and the family wishes to avoid succession costs that occur if there is no
qualified family member to replace the controlling family chairman.
Additionally, Table 5 provides evidence on whether a family is less likely to exit
if it enjoys larger private benefits of control. My first proxy for these benefits is wealth
expropriation via excess cash compensation received by the chairman. I show that there is
no significant difference between the median excess cash compensation received by the
chairmen of sample and matched firms. My second proxy for these benefits is whether
the firm has dual class stock. I find a result that is opposite to the prediction of the
hypothesis concerning private benefits of control. Specifically, I show that the presence
of dual class stock in a firm is positively related to whether a family exits from its
ownership.
Table 5 also documents whether families that have greater constraints on their
ability to expropriate wealth from minority shareholders are more likely to exit from their
ownership. I find no evidence that this is the case. I show that the probability that a
family exits from its ownership is not associated with whether there is a compensation or
audit board sub-committee that has no family members sitting on it. I also find that this
probability is not related to whether a firm has a Big Six auditor or whether cumulative
voting is allowed. As well, Table 5 shows that the likelihood that a family exits from its
ownership is not associated with possible non-pecuniary private benefits of control
enjoyed by this family. Specifically, I show that this probability is not associated with a
dummy variable for whether a family-controlled firm or one of its subsidiaries owns a
26
professional sports team, newspaper, magazine, television or radio station, or produces
movies or television shows. In sum, my results provide no support for the hypothesis that
families are less likely to exit the greater are their private benefits of control.
Finally, Table 5 shows if the magnitude of outside block ownership is associated
with whether a family exits. The results show that outside block ownership is positively
associated with the likelihood of an exit at the one percent level. This could suggest that
the monitoring provided by outside blockholders leads to families enjoying smaller
private benefits of control and consequently being more open to the idea of an exit from
their ownership. However, it is also possible that causality runs in the opposite direction.
For instance, this association could be the result of outside blockholders only purchasing
blocks in firms in which smaller conflicts of interest exist between the family and other
shareholders and in which the family is more open to the idea of selling its controlling
block.
Table 6 provides results from tests of theory of the firm hypotheses related to
optimal risk-bearing and the separation of ownership and management expertise. First,
this table documents that the change in average monthly stock return volatility in a firm’s
industry between the period 36 to 18 months and 18 months to 1 month prior to the
month of the announcement of the transaction leading to the exit of a family is not
statistically different between sample and matched firms. This suggests that an increase
in equity risk, as measured by the equity risk in the firm’s industry, does not affect the
likelihood that a family exits.11
11
I find the same result if I consider the change in a firm’s own standard deviation of stock returns over the
same periods.
27
Table 6 also documents that the median 1997 inflation-adjusted market value of
equity for sample firms is approximately 93 million dollars while that of matched firms is
about 45 million dollars. The difference between the two values is significant at the one
percent level. This is consistent with the Demsetz and Lehn (1985) argument that the
larger is a firm with concentrated ownership the higher is the firm’s cost of capital.
Consequently, controlling families of larger firms are more likely to exit from their
ownership.12
Finally, Table 6 shows that the number of segments in which the firm operates is
significantly different at the one percent level between sample and matched firms.
Although the median values are both equal to one, the mean values, which are not
tabulated, are 1.62 for sample firms and 1.28 for matched firms. Hence, the distribution
of the number of segments in which the firm operates is more right-tailed for sample than
for matched firms. This suggests that sample firms are more likely to operate in more
than one business segment. Thus, this is consistent with the idea that a controlling family
of a firm with complex operations exits as a result of inefficiencies created if in such a
firm the same individuals are both the principal owners and managers of the firm.13
12
I note that this result is also consistent with the financial slack explanation for why a controlling family
exits from its ownership. This is because costs resulting from the controlling family not having access to
the financing needed to fully invest in the firm’s growth opportunities will be larger the greater is the
market value of the equity of the firm. However, in multivariate tests the market value of the firm’s equity
remains positively associated with the likelihood that a family exits even after controlling for whether the
firm is financially constrained and operates in an industry with significant investment opportunities. This
suggests that the positive association between the likelihood that a family exits and the market value of the
firm’s equity is the result of excessively high costs of capital in large firms with concentrated ownership.
13
Such a scenario could be a result of generational issues within the family. For instance, the founder of
the firm might organize a firm having a competitive advantage due to this firm having some particular
innovation. However, as the firm grows, the founder’s descendants might diversify the operations of the
firm beyond the area of the firm’s competitive advantage.
28
Table 7 shows whether the timing and financial slack explanations for why a
family exits from its ownership are supported. This table documents that the change in
the median industry market-to-book ratio of assets between the year three years prior to
the exit year and the pre-exit year is positively associated with the likelihood that a
family exits from its ownership. This suggests that the greater is the two-year increase in
the market’s valuation of growth prospects in a family-controlled firm’s industry, the
more likely will a family be to exit from its ownership. Hence, this result provides
support for the timing explanation.14,15
However, in contrast to IPO studies that find owners time the sale of their shares
to follow a year during which operating performance improves, I find no evidence that
operating performance of sample firms improves during the pre-exit year. This is the case
whether I consider the unadjusted change in operating performance or the industryadjusted change in operating performance. I also show that changes in operating
performance using either of these two measures are not significantly different between
sample and matched firms. Hence, operating performance results provide no support for
the timing explanation.
Finally, Table 7 provides evidence on whether problems resulting from
insufficient financial slack are likely to explain why a family exits from its ownership.
14
The results are qualitatively the same if I replicate this test using the change in the firm’s own market-tobook ratio of assets over the same period.
15
Although I do not tabulate this result, I also examine whether the change in the median market-to-book
ratio of assets in a firm’s industry during the two years subsequent to the exit year is negatively related to
whether a family exits. Such a finding would be consistent with families timing their ownership exits with
peaks in market overoptimism concerning growth prospects in the firm’s industry. However, I find that the
change in this ratio during the two years subsequent to the exit year is unrelated to whether a family exits
from its ownership.
29
Specifically, I test whether the likelihood that a family exits is associated with a familycontrolled firm having a lack of financial slack and operating in an industry with
significant growth opportunities. Such a finding could suggest that because of insufficient
financial slack, the firm is unable to fully invest in its growth opportunities. Hence, if the
family sells the firm to an acquirer with better access to financing, the sale could result in
a creation of real value. I find no support for this explanation for why a family exits from
its ownership. Specifically, I do not find evidence that firms controlled by families that
exit from their ownership are more likely to be cash constrained and operate in industries
with higher growth opportunities.
4.3
Multivariate findings
Table 8 provides multivariate evidence from probit models on the empirical
relevance of my three explanations for why a family exits from its ownership. I include
two control variables in my probit regressions. The first variable is a proxy variable for
whether the industry in which a family-controlled firm conducts its business experienced
an economic shock during the four-year period prior to the exit of the family. This
variable is similar to that used by Mitchell and Mulherin (1996) as a proxy for industry
sales shocks. It is measured as the absolute value of the difference between the pre-exit
year four-year sales growth in a firm’s industry and the four-year sales growth of all
remaining non-financial Compustat firms during the same period. I use this control
variable because a majority of the controlling family ownership exits that I study take
place during the period from the middle through the end of the 1980s. This is a period
during which significant mergers and acquisitions activity takes place. Mitchell and
30
Mulherin (1996) suggest that much of this activity was the result of restructuring events
in industries that experienced economic shocks. Hence, in investigating the empirical
relevance of my three explanations for why a family exits from its ownership, I examine
whether economic shocks within particular industries might be an underlying cause of
these exits.
I do not find evidence that my economic shock variable is associated with
whether a family exits from its ownership. Also, including this variable in my regressions
does not affect the results concerning my other variables. Hence, it does not seem likely
that any of the other variables in the models act as proxy variables for whether an
economic shock in a family-controlled firm’s industry causes a family to exit from its
ownership. Finally, although I do not tabulate this result, I do not find even in the
univariate case that my economic shock variable explains the likelihood that a family
exits from its ownership.
The second control variable in my probit models is the percentage ownership of
the cash flow rights of the family. This variable helps to control for the level of
undiversified wealth that a family has invested in the firm. Since the level of this
undiversified wealth affects a family’s tolerance of firm risk it makes tests concerning
whether the market value of the firm’s equity or an increase in firm risk is associated with
the likelihood that a family exits more meaningful.
The results from my multivariate models show that even after controlling for
other firm characteristics, families are still more likely to exit if the chairman is older or
if he is 64 years or older and there are no other family members among the three highest
paid executives of the firm. Additionally, similar to the univariate case, I do not find any
31
evidence that the magnitude of private benefits of control enjoyed by the family are
negatively associated with the likelihood of an exit. I find that excess cash compensation
received by the chairman is not associated with the likelihood of a family exit.16
Furthermore, I do not find that if a firm has dual class stock this decreases the likelihood
of a family ownership exit or that if a firm has an audit board sub-committee that has no
family member that sits on it this increases the probability of a family ownership exit.
Finally, the results from these two models are also consistent with univariate findings that
there is a positive association between outside block ownership and the likelihood of an
exit.
As well, Table 8 shows that an increase in equity risk is not associated with the
likelihood that a family exits. However, I document that the change in operating
performance during the pre-exit year is negatively associated with the likelihood that a
family exits. Furthermore, although I do not tabulate this result, I find that the change in
industry-adjusted operating performance during the pre-exit year is also negatively
associated with whether a family exits. The results concerning the pre-exit year change in
operating performance are consistent with several different scenarios. If a decrease in
operating performance increases a family’s perception of firm risk, and this family can
rapidly execute an exit strategy, these results are consistent with the idea that a
16
In order to determine whether this finding is robust to alternate specifications in the regression of total
chairman cash compensation on market value of equity and return on assets, I try two alternate
specifications. First, to control for any effect that the investment opportunity set has on chairman
compensation, I include an independent variable consisting of the median pre-exit year industry market-tobook ratio of assets. Second, to account for the fact in some cases a chairman might receive a lower salary
if he is not also the president or CEO of the firm, I include an independent variable that captures whether
the chairman does not hold either of the positions of president or CEO and if the chairman is not the highest
paid executive of the firm. Neither of these alternate specifications changes the univariate or multivariate
result that excess chairman cash compensation is unrelated to the likelihood that a family exits.
32
controlling family exits in order to avoid costs resulting from an increase in firm risk.
However, these results could also be consistent with this drop in performance informing
the family that the firm is not organized optimally and this family consequently exiting
from its ownership.
The results from the probit models also support the univariate findings that the
market value of the firm’s equity and the number of segments in which the firm operates
are positively associated with the likelihood that a family exits. It is interesting to note
that this is the case for the market value of equity even after controlling for the
percentage ownership of the cash flow rights of the family. Also, it is useful to mention
that the number of segments in which the firm operates remains a significant predictor of
the likelihood of exit even after controlling for the market value of equity. It is likely that
firms that operate in more than one segment are larger. Hence, it might have been
expected that after controlling for firm size, the number of segments in which the firm
operates would no longer predict the likelihood that a family exits from its ownership.
The multivariate results provide no support for the timing explanation. The
change in operating performance during the pre-exit year, as already mentioned, is
negatively associated with whether a family exits. Moreover, the change in the median
industry market-to-book ratio of assets between the year three years prior to the exit year
and the pre-exit year is no longer a significant predictor of the likelihood that a family
exits. Finally, the multivariate results are also inconsistent with a family exiting as a
result of problems caused by insufficient financial slack.
Table 9 provides the results of an exogeneity test for whether outside block
ownership is likely to be an exogenous variable in my probit models. I perform this test
33
since as previously mentioned it could be argued that the positive association between
outside block ownership and the likelihood that a family exits is the result of the
probability that a family exits causing outside block ownership. I use a two-step
procedure suggested by Rivers and Vuong (1988) and outlined in Wooldridge (2001) to
investigate whether a particular continuous independent variable in a probit model may
be considered to be exogenous. First, in a reduced form model I regress outside block
ownership on all of the other independent variables from my first probit model in Table
8. Also, so that I may achieve identification, I include an additional exogenous
independent variable that is excluded from my structural model. Next, in my structural
model I run a probit regression in which a dummy variable for whether a family exits is
regressed on all of the variables from the first probit model in Table 8 and the residual
from the reduced form model. If the coefficient in front of this last variable is
significantly different from zero, I reject the null hypothesis that outside block ownership
is exogenous.
The additional variable that I include in my reduced form model is the natural
logarithm of the total dollar value of trading volume during the 12 months prior to the
month of the first announcement of the transaction leading to the exit of the family. I use
this variable because I expect that the lower is the dollar value of trading volume of a
firm’s stock, the greater will be information asymmetries between market participants
and the firm. Hertzel and Smith (1993) show that block private equity placements with
outside investors help to reduce underinvestmant resulting from asymmetric information
problems. Along the same lines, I expect that firms facing greater informational
asymmetries with the market are more likely to sell blocks of equity via private
34
placements and consequently are also more likely to have higher levels of outside block
ownership. Thus, I expect the dollar value of a stock’s trading volume to be negatively
associated with outside block ownership.
Table 9 shows that in the structural model the coefficient on the residual from the
first stage model is not significantly different from zero. Hence, I fail to reject the
hypothesis that outside block ownership is exogenous. Also, in tests that I do not tabulate,
I find the same result if I use this two-step procedure to test whether outside block
ownership is exogenous in my second probit model in Table 8. Finally, I also investigate
whether using total dollar trading volume instead of the natural logarithm of total dollar
trading volume affects the result that I cannot reject the hypothesis that total block
ownership is exogenous. I do not find that making this change affects this result.
In sum, the results of my exogeneity tests indicate that the positive association
between outside block ownership and the likelihood that a family exits is a consequence
of causality running from outside block ownership to a family exiting from its ownership.
This suggests that even in family-controlled firms, outside blockholders have a
monitoring role and that their monitoring increases the likelihood that a family accepts to
sell its controlling block in the firm.
4.4
Discussion of results related to dual class stock
The result that the presence of dual class stock is positively associated with
whether a family exits from its ownership in the firm merits further discussion. Although
the study’s hypothesis concerning private benefits of control predicts that the presence of
dual class stock is negatively associated with the likelihood of a family exit, there is a
35
literature that predicts that the presence of such stock is positively associated with a
family selling its controlling block. Recent arguments made in studies such as Zingales
(1995), Bebchuk and Zingales (1996), and Bebchuk (1999) suggest that dual class stock
is used by owners who attempt to maximize the surplus they receive when they sell their
ownership stake in a two-stage sale. First, owners sell cash flow rights to dispersed
shareholders. Next, they sell their controlling block to some potential buyer. The models
in these studies show that the more the cash flow rights that are sold off to dispersed
shareholders prior to the sale of the controlling block, the greater is the surplus the
owners of the firm capture from the sale of their ownership stake. Since dual class stock
permits owners to sell more cash flow rights to dispersed shareholders while still
retaining control of the firm, the presence of such stock in a firm is consistent with
owners trying to maximize the surplus they receive when they eventually sell their
controlling block to an outsider. Thus, the presence of dual class stock could increase the
likelihood that owners of a firm plan to sell their controlling block. This would be
consistent with the result that the presence of dual class stock is positively associated
with the likelihood that a family exits from its ownership.
4.5
Additional tests: Comparisons with family-controlled firms that are taken private
I also compare my sample of firms with families that exit from their ownership
with a comparison sample consisting of publicly traded firms controlled by families that
take their firms private during the years 1984-1998. I use this comparison sample because
a family that undertakes a going-private transaction essentially undertakes an opposite
strategy from that of a family that exits from its ownership. Hence, in many instances
36
hypothesized effects of predictor variables on the likelihood that a family exits from its
ownership are opposite when the likelihood that a family undertakes a going private
transaction is considered. For instance, my study hypothesizes that a family is more likely
to exit if the controlling family chairman is near retirement age and there are no qualified
family members to succeed him. Conversely, it should be expected that a family is less
likely to take its firm private if the chairman is close to retirement and there are no family
members qualified to succeed him.
Firms in my comparison sample consisting of going-private transactions are
identified from the SDC database. However, I do not match firms in this comparison
sample to ones in my sample of firms with exiting controlling families. These firms are
controlled by an individual family that owns at least twenty percent of the cash flow and
voting rights of the firm and that has a family member who is the chairman of the firm.
Additionally, firms are limited to ones in which the family was the major participant in
the going-private transaction. I search through merger proxy statements, SDC transaction
reports, and news stories found on Lexis Nexis to ensure that this last requirement is met.
The final comparison sample made up of firms controlled by individual families that take
their firms private consists of twenty firms.
Tables 10-13 show the results of tests that use the comparison sample consisting
of firms controlled by families that take their firms private to replicate the earlier
univariate tests whose results are presented in tables 4-7. I report whether I find
significant differences between sample and comparison firms for median and proportion
values. However, I note that the sample size of twenty for the comparison sample of
going-private transactions makes it difficult to find that median or proportion values
37
between sample and comparison sample firms significantly differ. Hence, my tests are
likely to have low power. Finally, in my tests that use this comparison sample, I do not
verify whether higher pecuniary private benefits of control are negatively associated with
the likelihood that a family exits from its ownership. This is because I expect that if a
family enjoys such benefits via expropriating wealth from minority shareholders, this
family will have an incentive to neither exit from its ownership in the firm nor buy the
shares of the minority shareholders from which it expropriates wealth.
Table 10 provides descriptive statistics of governance variables and firm financial
characteristics for sample and comparison firms. The only significant difference that is
documented is for the pre-exit year market-to-book ratio of assets. The results from Table
10 suggest that a family-controlled firm taken private by its controlling family has less
valuable growth opportunities than does a family-controlled firm in which the family
exits from its ownership.
Table 11 provides results for tests of theory of the firm hypotheses related to the
CEO succession process and agency costs. First, this table shows that the median ages of
the chairmen of sample and comparison firms are not statistically different from one
another. However, I find that whether the controlling family chairman is 64 years or older
and there are no other family members among the three highest paid executives of the
firm is positively associated with the likelihood that a family exits. What is remarkable
about this result is that in none of the twenty cases in which a family takes its firm private
does it occur that a controlling family chairman is 64 years or older and there are no other
family members among the three highest paid executives of the firm. Since potential
succession costs could be particularly high for a family-controlled firm that is taken
38
private by a chairman near retirement age who has no family cohorts among the top three
executives of the firm, these results are consistent with the idea that families try to avoid
high succession costs.
I find no other significant differences between medians or proportions for the
firms in the going-private comparison sample and those in my main sample of interest.
However, it is worthy of mention that Table 12 documents that the median 1997
inflation-adjusted market value of equity for sample firms is almost twice that of
comparison firms. A one-tailed test shows that this difference is significantly different
from zero. This is consistent with the Demsetz and Lehn (1985) argument that the larger
is a firm with concentrated ownership, the higher will be its cost of capital. Hence, the
larger is a family-controlled firm, the more likely should a family be to exit from its
ownership, and the less likely should a family be to take the firm private.
5.0
Conclusion
My study makes two main contributions. First, it increases our understanding of
what causes concentrated ownership structures to become dispersed. I show that the
decision made by controlling owners of public firms to proceed to the stage of the sale of
the firm in which their remaining ownership stake is sold is best explained by theories of
the firm related to the CEO succession process, optimal risk-bearing, and the separation
of ownership and management expertise.
Second, my findings increase our knowledge of the broader issue whether costs of
concentrated ownership are large. My results suggest that costs of concentrated
ownership are more important in larger firms. Additionally, my findings show that costs
39
of concentrated ownership are likely to be higher in firms with complex operations that
are run by their principal owners. Finally, my results also suggest that costs resulting
from private benefits of control enjoyed by controlling owners of American firms are
likely to be small. This is consistent with arguments that as a result of the superior legal
protection of minority shareholders in the United States, controlling owners of American
firms cannot easily expropriate wealth from non-controlling shareholders.
In closing, I note that a number of issues remain concerning why controlling
owners exit from their ownership and whether costs of concentrated ownership are
significant. First, I only examine exit strategies in which controlling owners exit from all
of their ownership. Hence, my results cannot necessarily be used to explain why such
owners undertake other types of exit strategies. For instance, controlling owners could
attempt to exit from only part of their ownership via an equity carve-out or a seasoned
equity offering. Thus, it may be useful to determine whether my study’s results hold if
only partial exits of controlling owners from their ownership are examined. Second, the
firms that I look at are American firms and it is likely that there is some heterogeneity
across different countries as to what causes controlling owners to exit from their
ownership. For instance, it is probable that in countries with weaker legal protection of
minority shareholders that controlling owners are more likely to pursue their own
objectives and expropriate wealth from minority shareholders. Hence, it could be
interesting to determine whether in such countries the likelihood that controlling owners
exit from their ownership is found to be inversely related to proxies for the private
benefits of control enjoyed by these owners.
40
References
Agrawal, A., and N. J. Nagarajan, 1990, Corporate capital structure, agency costs, and
ownership control: The case of all equity firms. Journal of Finance 45, 13251331.
Anderson, R.C., and D.M. Reeb, 2001, Founding family ownership and firm
performance. Working Paper, American University
Barclay, M. J. and C. G. Holderness, 1989, Private benefits from control of public
corporations. Journal of Financial Economics 25, 371-395.
Barclay, M. J. and C. G. Holderness, 1992, The law and large-block trades. Journal of
Law and Economics 35, 265-294.
Bates, T., T. Jandik, K. Lehn, 2000, Promotion incentives and executive compensation in
family firms. Working Paper, University of Pittsburgh
Bebchuk, L. A., 1999, A rent-protection theory of corporate ownership and control.
Working paper, Harvard Law School
Bebchuk, L. A., and L. Zingales, 1996, Corporate ownership structures: Private versus
social optimality. NBER Working Paper
Berry, T. K., J. M. Bizjak, M. L. Lemmon, and L. Naveen, 2000, CEO turnover and firm
diversification. Working paper, Texas A&M University
Brennan, M.J., and J. Franks, 1997, Underpricing, ownership and control in initial public
offerings of equity securities in the UK. Journal of Financial Economics 45, 391
-413.
Brickley, J. A., J. S. Linck, and J. L. Coles, 1999, What happens to CEOs after they
retire? New evidence on career concerns, horizon problems, and CEO incentives.
Journal of Financial Economics 52, 341-377.
Core, J. E., R. W. Holthausen, and D. F. Larcker, 1999, Corporate governance, chief
executive officer compensation, and firm performance. Journal of Financial
Economics 51, 371-406.
DeAngelo., H., and L. DeAngelo, 1985, Managerial ownership of voting rights: A study
of public corporations with dual classes of stock. Journal of Financial Economics
14, 33-69.
DeAngelo., H., and L. DeAngelo, 2000, Controlling shareholders and the disciplinary
role of corporate payout policy: a study of the Times Mirror Company. Journal of
Financial Economics 56, 153-207.
41
Degeorge, F., and R. Zeckhauser, 1993. The reverse LBO decision and firm performance:
theory and evidence. Journal of Finance 48, 1323-1348.
Demsetz, H., and K. Lehn, 1985, The structure of corporate ownership: Causes and
consequences. Journal of Political Economy 93, 1155-1177.
Denis, D. J. and A. Sarin, 1999, Ownership and board structure changes in publicly
traded corporations. Journal of Financial Economics 52, 187-223.
Fama, E. F. and M. C. Jensen, 1983, Separation of ownership and control. Journal of
Law and Economics 26, 301-326.
Grossman, S. J., and O. D. Hart, 1988, One share-one vote and the market for corporate
control. Journal of Financial Economics 20, 175-202.
Heckman, J. J., H. Ichimura, and P. Todd, 1998, Matching as an econometric evaluation
estimator. Review of Economic Studies 65, 261-294.
Hertzel, M. and R. L. Smith, 1993, Market discounts and shareholder gains for placing
equity privately. Journal of Finance 48, 459-485.
Holderness, C. G., R. S. Kroszner, and D. P. Sheehan, 1999, Were the good old days that
good? Changes in managerial stock ownership since the great depression. Journal
of Finance 54, 435-469.
Holderness, C. G. and D. P. Sheehan, 1988, The role of majority shareholders in publicly
held corporations. Journal of Financial Economics 20, 317-346.
Holderness, C. G. and D. P. Sheehan, 1998, Constraints on large-block shareholders.
NBER Working Paper.
H. R. Glenn, and D. Palia, 1995, Benefits of ownership, managerial ownership, and the
stock returns of acquiring firms. NBER Working Paper.
J. B., Kini, O., 1994, The post-issue operating performance of IPO firms. Journal of
Finance 49, 1699-1726.
Jung, K., Y. Kim, and R. M. Stulz, 1996, Timing, investment opportunities, managerial
discretion, and the security issue decision. Journal of Financial Economics 42,
159-185.
La Porta, R., F. Lopez-De-Silanes, and A. Shleifer, 1999, Corporate ownership around
the world. Journal of Finance 54, 471-517.
42
La Porta, R., F. Lopez-De-Silanes, A. Shleifer, and R. Vishny, 2000, Investor protection
and corporate governance. Journal of Financial Economics 58, 3-27.
Lease, R., J., McConnell, and W. Mikkelson, 1983, The market value of control in
publicly traded corporations. Journal of Financial Economics 11, 439-471.
Lease, R., J., McConnell, and W. Mikkelson, 1984, The market value of differential
voting rights in publicly traded corporations. Journal of Business 57, 443-467.
Lerner, J., 1994, Venture capitalists and the decision to go public. Journal of Financial
Economics 35, 293-316.
Mello, A. and J. Parsons, 1998, Going public and the ownership structure of the firm.
Journal of Financial Economics 49, 79-109.
Mikkelson, W.H., M. Partch, and K. Shah, 1997. Ownership and operating performance
of companies that go public. Journal of Financial Economics 44, 281-308.
Mitchell, M. L. and J. H. Mulherin, 1996, The impact of industry shocks on takeover and
restructuring activity. Journal of Financial Economics 41, 193-229.
Morck R., A. Shleifer, and R. W. Vishny, 1989, Alternative mechanisms for corporate
control. American Economic Review 79, 842-852.
Myers, S. and N. S. Majluf, 1984, Financing decisions when firms have information that
investors do not. Journal of Financial Economics 13, 187-221.
Pagano, M., F. Panetta, F, and L. Zingales, 1998, Why do companies go public? An
empirical analysis. Journal of Finance 53, 27-64.
Parino, R., 1997, CEO turnover and outside succession, A cross-sectional analysis.
Journal of Financial Economics 46, 165-197.
Partch, M.M., 1987, The creation of a class of limited voting common stock and
shareholder wealth, Journal of Financial Economics 18, 313-339.
Ritter, J. R., 1991, The long-run performance of initial public offerings, Journal of
Finance 46, 3-27.
Rivers, D, and Q. H. Vuong, 1988, Limited information estimators and exogeneity tests
for simultaneous probit models, Journal of Econometrics 39, 347-366.
Shivdasani, A., 1993, Board composition, ownership structure, and hostile takeovers.
Journal of Accounting and Economics 16, 167-198.
43
Shleifer, A., and R. Vishny, 1986, Large shareholders and corporate control. Journal of
Political Economy 94, 461-488.
Shleifer, A., and R. Vishny, 1997, A survey of corporate governance. Journal of
Finance 52, 737-783.
Vancil, R.F., 1987, Passing the baton: Managing the process of CEO succession, Harvard
Business School Press, Boston.
Walkling, R. A. and M. S. Long, 1984, Agency theory, managerial welfare, and takeover
bid resistance. Rand Journal of Economics 15, 54-68.
Weisbach, M., 1988, Outside directors and CEO turnover. Journal of Financial
Economics 37, 159-188.
Wooldridge, J. M., 2001, Econometric analysis of cross section and panel data. MIT
Press, Cambridge, Massachusetts
Zingales, L., 1995, Insider ownership and the decision to go public. Review of Economic
Studies 62, 425-448.
Zingales, L., 1995, What determines the value of corporate votes? Quarterly Journal
of Economics 110, 1075-110.
Table 1: Summary of hypotheses tested in the study
Hypotheses related to the theories of the firm explanation
2.1.1 A family exits from its ownership in order to avoid high succession costs.
2.1.2 The likelihood that a family exits from its ownership is negatively associated with the magnitude of the private benefits of
control enjoyed by this family.
2.1.3 A family is more likely to exit from its ownership the greater is the percentage of the firm owned by outside blockholders.
2.1.4 A family is more likely to exit from its ownership subsequent to an increase in the firm’s equity risk.
2.1.5 A family is more likely to exit from its ownership the larger is the market value of the firm’s equity.
2.1.6 A family is more likely to exit from its ownership if the firm has more complex operations.
Hypotheses related to the timing explanation
2.2.1 A family exits from its ownership to exploit favorable market conditions.
2.2.2 A family is more likely to exit from its ownership subsequent to an improvement in operating performance.
Hypothesis related to the financial slack explanation
2.3.1
A family is more likely to exit from its ownership if the firm has valuable growth opportunities but it is deficient in financial
slack.
Table 2: Number of sample firms included per year
Table 2 reports the number of sample and matched firms included per year of my sample period. Sample
firms are identified from the SDC (Securities Data Company) database using the FAM function that
identifies whether mergers or acquisitions took place that involved family-controlled target firms. Sample
firms are controlled by a family that owns at least twenty percent of the voting and cash flow rights of the
firm and that has a family member who is the chairman of the firm. Sample firms are limited to firms
whose controlling families exited from all of their ownership in the firm by accepting a bidder’s offer for
either all of the outstanding equity of the firm or for only the family’s controlling block interest in the firm.
Matched firms are identified from CDA Investment Technologies’ Spectrum publications. These firms are
controlled by a family that owns at least twenty percent of the voting and cash flow rights of the firm and
that has a family member who is chairman. Additionally, the controlling family of each matched firm does
not exit from its ownership during the two years subsequent to the exit of the controlling family of the
sample firm to which it is matched.
Year
# of sample firms included per year
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1
12
16
9
11
12
5
4
2
3
2
0
1
1
2
Total sample
firms
81
Total sample
and matched
firms
162
Table 3: Distribution of sample and matched firms by industry
Table 3 shows the distribution of sample and matched firms by industry. There are 81 sample firms whose
controlling families exit from their ownership and 81 matched firms whose controlling families do not exit
from their ownership. The sample period is 1984-1998.
Industry description
SIC Codes
Sample firms
Matched firms
Crops
Natural resource extraction
Operative builders
Electrical work
Food products
Apparel and textile mill products
Lumber, wood products, and mobile homes
Furniture
Printing and publishing
Pharmaceutical preparations and cosmetics
Rubber and plastic products
Footwear
Metal products
Industrial machinery
Electronic/electric equipment
Motor vehicle parts
Instruments and related products
Miscellaneous manufacturing
Trucking
Air transportation
Energy
Wholesale
Retail
Services
1
13,14
15
17
20
22,23
24
25
27
28
30
31
33,34
35
36
37
38
39
42
45
49
50,51
52-59
70-87
1
1
3
1
2
5
1
2
2
6
3
1
2
4
3
2
1
3
3
0
0
5
15
15
0
1
0
0
5
3
1
3
1
8
1
0
3
6
6
1
8
1
1
1
2
5
11
13
Table 4: Descriptive statistics
Table 4 provides descriptive statistics for variables not directly used to test the study’s hypotheses. There are 81 sample firms whose controlling families exit
from their ownership and 81 matched firms whose controlling families do not exit from their ownership. The sample period is 1984-1998. Controlling family
inside directors are officers of the firm who are controlling family members or family members of such officers. Non-controlling family inside directors are
officers of the firm who are not controlling family members or family members of such officers. Gray directors are lawyers, bankers, or consultants who are
neither officers of the firm nor family members of such officers. Industry-adjusted total liabilities/assets is calculated as total liabilities/assets for a firm minus the
median ratio in a firm’s industry as measured by the firm’s four-digit SIC code.
Variable
Sample firms
Matched firms
Percentage ownership of cash flow rights of the controlling family
38.30
40.27
Number of years of service of the controlling family chairman
21
18
Board size
7***
6
Fraction of board consisting of outside directors
0.29
0.33
Fraction of board consisting of controlling family inside directors
0.27
0.25
Fraction of board consisting of non-controlling family inside directors
0.23
0.17
Fraction of board consisting of gray directors
0.14
0.20
Total liabilities/assets
0.47
0.46
Industry-adjusted total liabilities/assets
-0.06
-0.07
Operating income/assets
0.16
0.13
Net income/assets
0.05
0.06
Market-to-book ratio of assets
1.15
1.18
Panel A: Governance characteristics
Panel B: Financial characteristics
Median and proportion values are reported. ***, **, and * represent significance at the 1, 5, and 10 percent levels , respectively, for the two-tailed chi-square test corrected for continuity to determine
whether proportions differ or the two-tailed Wilcoxon test to determine whether medians differ.
Table 5: Univariate tests of theory of the firm hypotheses (governance variables)
There are 81 sample firms whose controlling families exit from their ownership and 81 matched firms whose controlling families do not exit from their ownership. The sample
period is 1984-1998. Excess compensation is the residual from a regression of cash compensation on market value of equity and return on assets. Cash compensation and market
value of equity are in 1997 dollars adjusted for inflation.
Variable
Sample
firms
Matched
firms
Hypothesis tested
Age of the controlling family chairman
63***
56
A family exits from its ownership in order to avoid high succession costs
The controlling family chairman is 64 years or older and there are no other
controlling family members among the three highest paid executives of the firm
0.27**
0.12
Same as above
Excess compensation received by controlling family chairman in 1997 dollars
-45,470
-61,579
The likelihood that a family exits from its ownership is negatively associated
with the magnitude of the private benefits of control enjoyed by this family
Firm has dual class stock
0.17*
0.06
Same as above
There is an audit board sub-committee and no controlling family member sits on it
0.60
0.72
Same as above
There is a compensation board sub-committee and no controlling family member
sits on it
0.38
0.33
Same as above
Firm has a Big Six auditor
0.85
0.90
Same as above
Firm has cumulative voting
0.14
0.17
Same as above
Firm owns a professional sports team, newspaper, television or radio station, or
produces movies or television shows
0.05
0.02
Same as above but non-pecuniary private benefits of control are considered
Total percentage outside block ownership
7.83***
0
A family is more likely to exit the greater is the percentage of the firm owned by
outside blockholders
Median and proportion values are reported. ***, **, and * represent significance at the 1, 5, and 10 percent levels , respectively, for the two-tailed chi-square test corrected for continuity to determine whether proportions
differ or the two-tailed Wilcoxon test to determine whether medians differ.
Table 6: Univariate tests of theory of the firm hypotheses (firm characteristics)
There are 81 sample firms whose controlling families exit from their ownership and 81 matched firms whose controlling families do not exit from their ownership. The sample period is 1984-1998.
Change in mean industry stock price volatility is measured as the change in average monthly stock return volatility in a firm’s industry between the periods 36 to 18 months and 18 months to 1 month
prior to the month of the announcement of the transaction leading to the exit of a family. Market value of equity is in 1997 dollars adjusted for inflation.
Variable
Sample firms
Matched firms
Hypothesis tested
Change in mean industry stock price volatility
-0.02
-0.02
A family is more likely to exit from its ownership the greater is the firm’s equity risk.
Market value of equity (millions of 1997 dollars)
93.51***
45.38
A family is more likely to exit the greater is the market value of the firm’s equity.
# of business segments in which operates the firm
1***
1
A family is more likely to exit if the firm has more complex operations.
Median values are reported. ***, **, and * represent significance at the 1, 5, and 10 percent levels , respectively. These significance levels correspond to the two-tailed Wilcoxon test.
Table 7: Univariate tests of timing and financial slack hypotheses
There are 81 sample firms whose controlling families exit from their ownership and 81 matched firms whose controlling families do not exit from their ownership. The sample period is 1984-1998.
Year –3 to year –1 change in the median industry market to book ratio of assets is the median change in the market-to-book ratio of assets in a firm’s industry between the years three years prior to
and one year prior to the exit year where a firm’s industry is measured by its four-digit SIC code. Year -1 median industry market-to-book ratio of assets is the pre-exit year median market-to-book
ratio of assets in a firm’s industry as measured by its four-digit SIC code. Year –1 change in operating performance is measured as pre-exit year operating income before amortization and depreciation
scaled by book value of assets minus this same ratio for the year prior to the pre-exit year. Industry-adjusted operating performance is firm operating performance minus the median operating
performance in a firm’s industry as measured by its four-digit SIC code. Hi pre-exit year industry market-to-book ratio of assets and low firm industry-adjusted net working capital indicates that
during the pre-exit year a firm’s median industry market-to-book ratio of assets is above that of the median sample and matched firm and net working capital standardized by total book assets minus
the same ratio for the median firm in the firm’s industry is below that of the median sample and matched firm. Hi pre-exit year median industry market-to-book ratio of assets and low (negative)
change in firm net working capital from year –3 to year -1 indicates that during the pre-exit year a firm’s median industry market-to-book ratio of assets is above that of the median sample and
matched firm and during the period three years prior to the exit year to the year one year before this year the change in net working capital standardized by total book assets for the firm is below that
of the median sample and matched firm.
Variable
Sample firms
Matched firms
Hypothesis tested
Year –3 to year –1 change in the median industry
market-to-book ratio of assets
0.026**
-0.088
A family exits from its ownership to exploit favorable market conditions.
Year -1 median industry market-to-book ratio of
assets
1.212
1.310
Same as above
Year -1 change in operating performance
-0.006
-0.005
A family is more likely to exit from its ownership subsequent to an improvement in operating
performance
Year -1 change in industry-adjusted operating
performance
-0.006
-0.001
Same as above
Hi pre-exit year median industry market-to-book
ratio of assets and low firm industry-adjusted net
working capital
0.198
0.321
A family is more likely to exit from its ownership if the firm has valuable growth opportunities
but it is deficient in financial slack.
Hi pre-exit year median industry market-to-book
ratio of assets and low (negative) change in firm net
working capital from year –3 to year -1
0.185
0.296
Same as above
Panel A: Timing explanation variables
Panel B: Financial slack explanation variables
Median and proportion values are reported. ***, **, and * represent significance at the 1, 5, and 10 percent levels , respectively, for the two-tailed chi-square test corrected for continuity to determine whether proportions
differ or the two-tailed Wilcoxon test to determine whether medians differ.
Table 8: Multivariate probit regressions
There are 81 sample firms whose controlling families exit from all of their ownership and 81 matched firms
whose controlling families do not exit from their ownership. The sample period is 1984-1998. Models 1
and 2 are cross-sectional probit regressions in which the dependent variable equals one if a firm is one with
a controlling family that exits from all of its ownership and equals zero if the firm consists of a matched
firm. Market value of equity and cash compensation are in 1997 dollars adjusted for inflation. Industry
shock is measured as the absolute value of the difference between the pre-exit year four years sales growth
in a firm’s industry and the four year sales growth of all remaining non-financial Compustat firms during
the same period. Change in mean industry stock price volatility is measured as the change in average
monthly stock return volatility in a firm’s industry as measured by its 2-digit SIC code between the periods
36 to 18 months and 18 months to one month before the offer announcement month. Excess compensation
is the residual from a regression of total pre-exit year cash compensation of the controlling family chairman
of the board on pre-exit year market value of equity and return on assets. An outside ownership block is
defined as a cash flow rights block of at least 5 percent. Year –1 change in operating performance is
measured as pre-exit year operating income before amortization and depreciated scaled by book value of
assets minus this same ratio for the year prior to the exit year. Year –3 to year –1 change in median industry
M/B assets is the change in the median market-to-book ratio of assets in a firm’s industry between the years
three years prior to and one year prior to the exit year, where a firm’s industry is measured by its 4-digit
SIC code. Hi industry M/B assets and low firm net working capital dummy equals one if during the pre-exit
year a firm’s median industry market-to-book ratio of assets is above that of the median sample and
matched sample firm and net working capital standardized by total book assets for the firm minus the
median ratio in a firm’s industry is below that of the median sample and matched sample firm. The PseudoR2 is computed as 1 – [Log Likelihood of full model/Log Likelihood of a model that includes only the
constant].
Model
Pred. Sign
Intercept
1
2
-1.540
(0.000)
-0.931
(0.000)
Industry sales shock
?
-0.020
(0.782)
-0.025
(0.752)
Pre-exit year controlling family ownership of cash flow rights
?
0.007
(0.016)
0.008
(0.006)
Age of the controlling family chairman
+
0.013
(0.003)
Controlling family chairman is 64 years or older and no other
controlling family members are among the 3 highest paid
executives of the firm dummy
+
Excess compensation
-
-0.000
(0.223)
-0.000
(0.173)
There is an audit board sub-committee and no controlling
family members sit on it dummy
+
-0.171
(0.089)
-0.148
(0.128)
Firm has dual class stock dummy
-
0.375
(0.020)
0.366
(0.025)
Total percentage outside block ownership
+
0.016
(0.000)
0.017
(0.000)
Pre-exit year natural logarithm of market value of equity
+
0.054
(0.069)
0.064
(0.026)
Change in mean industry stock price volatility
+
-0.169
(0.244)
-0.181
(0.239)
# of business segments in which operates the firm
+
0.117
(0.064)
0.134
(0.030)
Year –1 change in operating income/assets
+
-0.140
(0.004)
-0.132
(0.007)
Year –3 to –1 change in median industry M/B assets
+
0.016
(0.271)
0.015
(0.285)
Hi industry M/B assets and low firm net working capital
dummy
+
-0.154
(0.175)
-0.178
(0.107)
0.243
0.215
Pseudo-R2
N
0.211
(0.074)
162
162
Marginal effects estimates are presented. Significance levels for whether estimates are different from zero are in parentheses.
Estimates that are significantly different from zero are shown in bold font.
Table 9: Exogeneity test for total outside block ownership
There are 81 sample firms whose controlling families exit from all of their ownership and 81 matched firms
whose controlling families do not exit from their ownership. The sample period is 1984-1998. Market value
of equity and cash compensation are in 1997 dollars adjusted for inflation. Industry shock is measured as
the absolute value of the difference between the pre-exit year four years sales growth in a firm’s industry
and the four year sales growth of all remaining non-financial Compustat firms during the same period.
Change in mean industry stock price volatility is measured as the change in average monthly stock return
volatility in a firm’s industry as measured by its 2-digit SIC code between the periods 36 to 18 months and
18 months to one month before the offer announcement month. Excess compensation is the residual from
a regression of total pre-exit year cash compensation of the controlling family chairman of the board on
pre-exit year market value of equity and return on assets. An outside ownership block is defined as a cash
flow rights block of at least 5 percent. Year –1 change in operating performance is measured as pre-exit
year operating income before amortization and depreciated scaled by book value of assets minus this same
ratio for the year prior to the exit year. Year –3 to year –1 change in median industry M/B assets is the
change in the median market-to-book ratio of assets in a firm’s industry between the years three years prior
to and one year prior to the exit year, where a firm’s industry is measured by its 4-digit SIC code. Hi
industry M/B assets and low firm net working capital dummy equals one if during the pre-exit year a firm’s
median industry market-to-book ratio of assets is above that of the median sample and matched sample
firm and net working capital standardized by total book assets for the firm minus the median ratio in a
firm’s industry is below that of the median sample and matched sample firm. Natural logarithm of 12month dollar trading volume during the 12 months preceding the announcement month is the natural
logarithm of the total dollar value of trading for a firm’s stock during the 12 months prior to the month
when the first announcement of the transaction leading to the exit of the controlling family is made.
Dependent variable
1st stage OLS
regression
2nd stage probit
regression
Total outside block
ownership
Exit dummy
Intercept
21.800
(0.002)
-3.690
(0.009)
Industry shock
-1.477
(0.119)
-0.068
(0.754)
Pre-exit year controlling family ownership of cash flow rights
-0.251
(0.000)
0.016
(0.453)
Age of the controlling family chairman
0.039
(0.623)
0.033
(0.004)
Excess compensation
-0.000
(0.078)
-0.000
(0.343)
There is an audit board sub-committee and no controlling
family members sit on it dummy
3.298
(0.077)
-0.393
(0.247)
Firm has dual class stock dummy
-2.550
(0.349)
0.917
(0.032)
Total percentage outside block ownership
0.029
(0.724)
Pre-exit year natural logarithm of market value of equity
0.659
(0.298)
0.136
(0.070)
Change in mean industry stock price volatility
-4.065
(0.875)
-4.278
(0.242)
# of business segments in which operates the firm
0.599
(0.601)
0.302
(0.072)
Year –1 change in operating income/assets
6.606
(0.458)
-3.142
(0.012)
Year –3 to –1 change in median industry M/B assets
0.500
(0.856)
0.420
(0.274)
Hi industry M/B assets and low firm net working capital
dummy
-2.223
(0.265)
-0.406
(0.203)
Natural logarithm of 12-month dollar trading volume during the
12 months preceding the announcement month
-0.552
(0.109)
Residual from 1st stage regression
R-square adjusted
0.150
N
162
0.012
(0.882)
162
Regression coefficient estimates are presented. Significance levels for whether coefficients are different from zero are in parentheses.
Estimates that are significantly different from zero are shown in bold font.
Table 10: Descriptive statistics
Table 10 provides descriptive statistics for variables not directly used to test the study’s hypotheses. There are 81 sample firms whose controlling families exit
from their ownership and 20 comparison firms whose controlling families undertake going private transactions. The sample period is 1984-1998. Controlling
family inside directors are officers of the firm who are controlling family members or family members of such officers. Non-controlling family inside directors
are officers of the firm who are not controlling family members or family members of such officers. Gray directors are lawyers, bankers, or consultants who are
neither officers of the firm nor family members of such officers. Industry-adjusted total liabilities/assets is calculated as total liabilities/assets for the firm minus
the median ratio in a firm’s industry as measured by its four-digit SIC code.
Variable
Sample firms
Comparison firms
Percentage ownership of cash flow rights of the controlling family
38.30
42.94
Number of years of service of the controlling family chairman
21
28
Board size
7
7
Fraction of board consisting of outside directors
0.29
0.36
Fraction of board consisting of controlling family inside directors
0.27
0.29
Fraction of board consisting of non-controlling family inside directors
0.23
0.18
Fraction of board consisting of gray directors
0.14
0.20
Total liabilities/assets
0.47
0.56
Industry-adjusted total liabilities/assets
-0.06
-0.07
Operating income/assets
0.16
0.15
Net income/assets
0.05
0.03
Market to book ratio of assets
1.15*
1.06
Panel A: Governance characteristics
Panel B: Financial characteristics
Median and proportion values are reported. ***, **, and * represent significance at the 1, 5, and 10 percent levels , respectively, for the two-tailed chi-square test corrected for continuity to determine
whether proportions differ or the two-tailed Wilcoxon test to determine whether medians differ.
Table 11: Univariate tests of theory of the firm hypotheses using the going-private comparison sample (governance variables)
There are 81 sample firms whose controlling families exit from their ownership and 20 comparison firms whose controlling families undertake going private transactions. The sample period is 19841998. Excess compensation is the residual from a regression of cash compensation on market value of equity and return on assets. Cash compensation and market value of equity are in 1997 dollars
adjusted for inflation.
Variable
Sample
firms
Comparison
firms
Hypothesis tested
Age of the controlling family chairman
63
59.5
A family exits from its ownership in order to avoid high succession costs
Controlling family chairman is 64 years or older and there are no other family
members among the three highest paid executives of the firm
0.27**
0.00
Same as above
Excess compensation received by controlling family chairman
-62,271
69,627
None
Firm has dual class stock
0.17
0.15
None
There is an audit board sub-committee and no controlling family member sits on it
0.60
0.65
None
There is a compensation board sub-committee and no controlling family member
sits on it
0.38
0.55
None
Firm has a Big Six auditor
0.85
0.85
None
Firm has cumulative voting
0.14
0.25
None
Firm owns a professional sports team, newspaper, television or radio station, or
produces movies or television shows
0.05
0.15
The likelihood that a family exits from its ownership is negatively associated
with the magnitude of the non-pecuniary private benefits of control enjoyed by
this family
Total outside block ownership
7.83
0
A family is more likely to exit the greater is the percentage of the firm owned
by outside blockholders
Median and proportion values are reported. ***, **, and * represent significance at the 1, 5, and 10 percent levels , respectively, for the two-tailed chi-square test corrected for continuity to determine whether proportions
differ or the two-sample Wilcoxon test to determine whether medians differ.
Table 12: Univariate tests of theory of the firm hypotheses using the going-private comparison sample (firm characteristics)
There are 81 sample firms whose controlling families exit from their ownership and 20 comparison firms whose controlling families undertake going private transactions. The sample period is 19841998. Change in mean industry stock price volatility is measured as the change in average monthly stock return volatility in a firm’s industry between the periods 36 to 18 months and 18 months to 1
month prior to the month of the announcement of the transaction leading to the exit of a family. Market value of equity is in 1997 dollars adjusted for inflation.
Variable
Sample firms
Comparison firms
Hypothesis tested
Change in mean industry stock price volatility
-0.02
-0.01
A family is more likely to exit from its ownership the greater is the firm’s equity risk.
Market value of equity (millions of 1997 dollars)
93.51
50.41
A family is more likely to exit the greater is the market value of the firm’s equity.
# of business segments in which operates the firm
1
1
A family is more likely to exit if the firm has more complex operations.
Median values are reported. ***, **, and * represent significance at the 1, 5, and 10 percent levels , respectively. These significance levels correspond to the two-sample Wilcoxon test.
Table 13: Univariate tests of timing and financial slack hypotheses using the going-private comparison sample
There are 81 sample firms whose controlling families exit from their ownership and 20 comparison firms whose controlling families undertake going private transactions. The sample period is 19841998. Year –3 to year –1 change in the median industry market-to-book ratio of assets is the median change in the market-to-book ratio of assets in a firm’s industry between the years three years
prior to and one year prior to the exit year where a firm’s industry is measured by its four-digit SIC code. Year -1 median industry market-to-book ratio of assets is pre-exit year median market-tobook ratio of assets in a firm’s industry as measure by its four-digit SIC code. Year –1 change in operating performance is measured as pre-exit year operating income before amortization and
depreciation scaled by book value of assets minus this same ratio for the year prior to the pre-exit year. Industry-adjusted operating performance is firm operating performance minus the median
operating performance in a firm’s industry as measured by its four-digit SIC code. Hi pre-exit year industry market-to-book ratio of assets and low firm industry-adjusted net working capital indicates
that during the pre-exit year a firm’s median industry market-to-book ratio of assets is above that of the median sample and comparison firm and net working capital standardized by total book assets
minus the same ratio for the median firm in the firm’s industry is below that of the median sample and comparison firm. Hi pre-exit year median industry market-to-book ratio of assets and low
(negative) change in firm net working capital from year –3 to year -1 indicates that during the pre-exit year a firm’s median industry market-to-book ratio of assets is above that of the median sample
and comparison firm and during the period three years prior to the exit year to the year one year before this year the change in net working capital standardized by total book assets for the firm is
below that of the median sample and comparison firm.
Variable
Sample firms
Comparison firms
Hypothesis tested
Year –3 to year –1 change in the median industry
market-to-book ratio of assets
0.026
0.037
A family exits from its ownership to exploit favorable market conditions.
Year -1 median industry market-to-book ratio of
assets
1.212
1.224
Same as above
Year -1 change in operating performance
-0.006
-0.001
A family is more likely to exit from its ownership subsequent to an improvement in operating
performance
Year -1 change in industry-adjusted operating
performance
-0.006
-0.006
Same as above
Hi pre-exit year median industry market-to-book
ratio of assets and low firm industry-adjusted net
working capital
0.259
0.300
A family is more likely to exit from its ownership if the firm has valuable growth
opportunities but it is deficient in financial slack.
Hi pre-exit year median industry market-to-book
ratio of assets and low (negative) change in firm net
working capital from year –3 to year -1
0.272
0.250
Same as above
Panel A: Timing explanation variables
Panel B: Financial slack explanation variables
Median and proportion values are reported. ***, **, and * represent significance at the 1, 5, and 10 percent levels , respectively, for the two-tailed chi-square test corrected for continuity to determine whether proportions
differ or the two-tailed Wilcoxon test to determine whether medians differ.