Plan for the remaining part of the
course
Corporate governance, ownership and control of
firms around the world. Why differences across
countries?
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Law and Finance view
Other views (“political economy”, in particular)
Implications for financial development
Choice of corporate governance by companies
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Does good CG create value?
Incentives to practice good CG?
Effect of legal environment
Effect of government predation
1
Law and Finance
Legal
Shareholder
Protection
Possibilities for
insider expropriation
Ability to attract
external finance
Ownership and
control structures
Development
of financial
markets
La Porta, Lopez-de-Silanes, Shleifer, and Vishny (LLSV)
Main messages of the Law and Finance theory:
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Weak shareholder protection raises obstacles to financial market
development through hampering external finance
Weak shareholder protection results in greater ownership (and
control) concentration in firms. Ownership concentration is a
“second-best” response to bad institutions
Common law (Anglo-Saxon) countries have better shareholder
protection  more developed financial markets
2
How does it work?
La Porta et al (2002), Shleifer and Wolfenzon (2002)
Weak legal shareholder protection increases insider’s
(entrepreneur’s, manager’s) benefits from diversion/selfdealing/private benefit extraction  larger agency cost
Larger insider’s share creates better incentives  less diversion
(meaning higher equity valuation) for a given protection
Better shareholder protection  less diversion (higher equity
valuation) for a given insider’s share
Assume an insider needs to raise external finance by selling shares.
Then he bears the (agency) costs. He can try to minimize them by
retaining a greater fraction of equity. But this has two effects:
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Better incentives: commitment not to expropriate investors too much 
investors are more willing to provide funds
Lower share available for sale to outside investors limits insider’s ability
to raise funds
3
Under weak protection the incentive effect dominates
(see Note below). As a result:
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Insider retains more shares to compensate for low quality of
legal protection
However, it costs him a reduction in the funds raised
Moreover, this compensation is only partial. Despite an increase
in insider’s share there is still more expropriation under weaker
legal protection
Note: The (theoretical) result on the effect of law on
insider share is not quite robust. The following feature is
needed: marginal increase in insider’s share must have
greater effect on incentives under weak protection.
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La Porta et al (2002) test the latter, they get the predicted sign
but coefficient is insignificant
4
Conclusions.
Under weaker legal protection
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Higher private benefits of control and more self-dealing
Lower valuation of firms
Higher ownership concentration
Less funds is raised, i.e. smaller size of projects (firms)
Fewer firms are set up (fewer firms go public)
Stock markets are smaller
Empirics largely confirms these results (in fact, empirics
came out first)
Implication:
Why capital does not flow to developing countries?
Because they have worse investor protection
5
Another explanation for ownership concentration
in countries with weak shareholder protection
Burkart, Panunzi and Shleifer (2003):
Examine the decision of a founder to resign and hire
professional manager:
The founder can hire a manager, sell a part of his shares
and remain a large outside shareholder
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Large shareholder monitoring reduces managerial opportunism
Hence, it is more valuable when there is more room for
opportunism, i.e. under weak shareholder protection
I.e. outside ownership concentration grows as shareholder
protection worsens (i.e. is a substitute for shareholder protection)
However, monitoring/diversion tradeoff is costly. As legal
protection worsens this cost goes up, at some point the founder
decides to keep control “in the family”, instead of hiring a
manager
Indeed, family controlled firms are more widespread in countries
with weak shareholder protection
6
What about concentration of
control?
Control is not the same as ownership: they can be
separated
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Shares with differential voting rights
Pyramids
Cross-ownership
Trust agreements
In fact, outside US and UK, such separation is very
common
Greater separation and greater concentration of control
seem to be more common in countries with weak legal
shareholder protection
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Not surprising: control is very valuable there, more valuable than
CFR
Separating it from CFR gives possibility to retain control while
selling CFR
7
Example. Control structure of
Microsoft
Bill Gates (chairman) – 9.2%
Steven Ballmer (CEO) – 4.4%
Almost all the rest is free float (institutional
investors, mutual funds, individuals)
No pyramids, no cross holdings, only one
type of shares
8
Example. Nordström family control of Realia (Sweden)
Nordström family is the largest shareholder of Realia: control rights are 39.3%, though
CFR are only 2.66%
But its control is likely to be restricted by Blockfield Properties (14.1% of control rights)
Note: Realia has 2 classes of stock: 2.641 million of A-shares with 1 vote each and
42.922 million of B-shares with 1/10 vote each
9
Ownership and control around the
world
La Porta et al (JF 1999)
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Take 27 mainly developed countries, 20 largest firms
in each country
Trace ultimate beneficial owners.
At 20% control threshold only 36% of large
corporations in the world are widely held
30% of firms are family-controlled
In Continental Europe and Asia widely held firms are
rare and family-controlled firms are more common
In countries with high shareholder protection (mostly
Anglo-Saxon) widely held firms are common and
family-controlled firms are rare
10
Control of large publicly traded firms over the world (LLS (1999)).
High antidirector rights subsample
11
Control of large publicly traded firms over the world (LLS (1999)).
Low antidirector rights subsample
12
One-share one-vote, cross-shareholdings, and pyramids
(LLS (1999)). High antidirector rights subsample
13
One-share one-vote, cross-shareholdings, and pyramids
(LLS (1999)). Low antidirector rights subsample
14
Family control in large traded firms (LLS (1999)).
High antidirector rights subsample
15
Family control in large traded firms (LLS (1999)).
Low antidirector rights subsample
16
Example: Wallenberg family
Controls about 40% of Swedish stock market. Mostly through
Investor AB.
Investor AB core investments (from Investor AB website):
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ABB - power and automation technology (7.2% Stake, 7.2% Voting
rights)
Atlas Copco - industrial tooling and equipment (15.4% Stake, 21.2%
Voting rights)
Astra Zeneca - pharmaceuticals (3.5% Stake, 3.5% Voting rights)
Electrolux - consumer appliances (11.9% Stake, 28.2% Voting rights)
Ericsson - telecommunications (5.1% Stake, 19.5% Voting rights)
Husqvarna - Auto, chainsaw and sewing machine manufacturer (14.1%
Stake, 27.5% voting rights)
Saab - aviation and military technology (19.8% Stake, 38.0% Voting
rights)
Scania – heavy trucks, buses, engines (11% Stake, 20% Voting rights)
SEB - banking (20% Stake, 20.3% Voting rights)
17
Concentration of control at the country level.
East Asia
Source: Claessens, Djankov and Lang (JFE 2000), based on 2980 public
corporations, ultimate owners are traced, control threshold is 20%
18
Concentration of control at the country level.
Europe
Source: Faccio and Lang (2002), based on 5232 public
corporations, ultimate owners are traced, control threshold is 20%
19
How do controlling owners enhance
their control in Asia?
20
How do controlling owners enhance
their control in Europe?
Source: Faccio and Lang (2002)
21
How do controlling owners enhance their
control in Europe? Subsample of family
controlled firms
22
How large are largest
shareholders?
Average largest holder in listed companies
(in terms of voting rights):
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East Asia: from 10.33% in Japan to 35.25% in
Thailand
Europe: from 25.13% in UK to 54.50% in
Germany
In Russia: average largest holder in listed
companies controls 50+% ?
23
What’s the degree of separation of
ownership and control?
Average ratio of cash flow rights to control
rights:
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East Asia: from 0.6 in Japan to 0.94 in
Thailand
Europe: from 0.74 in Switzerland to 0.94 in
Spain
Russia ?
24
How valuable is control?
Control premia are higher in countries with
weaker shareholder protection, weaker
enforcement
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Difference between price of voting and nonvoting shares (Nenova (2003))
0% in Denmark, 2% in the US, 46% in Mexico
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Difference between price of block and market
price of dispersed shares (block premium)
(Dyck and Zingales (2002)).
2% in Denmark, 5% in the US, 30% in Mexico
25
Ownership concentration around
the world. Summary
Except US and UK
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ownership and control in firms are concentrated in the
hands of one or few large shareholders
These large shareholders often belong to few families
that control large part of the country’s economy
Concentration of control in firms and separation
of CR from CFR seem more widespread in
countries with weaker shareholder protection
Control is more valuable in countries with weak
shareholder protection, weak enforcement
26
Russia
Guriev and Rachinsky (2004)
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Control structure of 1700 large firms in 45
sectors in 2003. 60% of Russia’s total
industrial output.
Traced ownership to 627 ultimate owners or
groups of owners
Ended up with the list of 22 largest private
domestic owners (or groups), each of them
controlling assets that either generate > $700
million in sales or have > 20,000 employees
27
Ownership concentration in Russian
industry
Source: Gurev and Rachinsky (2004). Numbers are calculated using the proportional
method; if recalculated based on the majority rule numbers become bigger: 47% for
employment and 43% for sales.
28
Comparing Russia to other countries
Top 10 oligarchs (or groups) owned 60.2% of the
stock market in June 2003
In developed Continental European countries
top 10 families control 11-34% of the stock
market (Faccio and Lang 2002)
In East Asian countries top 10 families control:
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58% of the stock market in Indonesia
52% in Philippines
43% in Thailand
29
Costs and benefits of family control
for a firm
Benefits of ownership concentration:
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Reduces separation of ownership from control, typical
for US and UK firms
No pandering to short-term market pressures, focus
on long-term value
Family values?
Benefits related to groups/pyramiding
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Internal markets (capital, managerial, product)
Insurance against shocks (reduces fin. distress costs)
Political connections
30
Costs of ownership concentration
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Lack of diversification for large shareholders
Lack of liquidity of a firm’s stock
Agency problem: divergence of interest between large and small
shareholders, especially when controlling holder’s control rights
(CR) > his cash flow rights (CFR)
Uncontestable control – no market discipline
Costs of pyramids
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Magnify separation of control from CFR
Succession problem. What if a heir is less competent
than the founder? Dilemma:
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To pass control to the heir
To hire a professional manager, but then separation of ownership
from control
Note: Russian oligarchs are still too young to face the
succession problem (Felix and Tatiana Evtushenkov, Anton
Fedun, Olga Rashnikova…)
31
Additional economy level costs of
family control
What is good for a group may be bad for
economy
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Market power (especially in a closed
economy)
Misallocation of recourses (even if inside the
group allocation is efficient)
Political influence may harm other economy
participants (later on that)
32
Empirical evidence on performance
of family firms
Free-standing family controlled firms outperform
widely-held firms in the US (Anderson and Reeb
(2003))
Especially if the firm is relatively young (Morck et
al(1988), Anderson and Reeb (2003))
But (!) inherited control reduces firm value,
especially if the heir appointed as CEO did not
get proper education (Perez-Gonzales (2002))
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Also, Anderson and Reeb (2003) find that firms
managed by the founder descendants are valued
lower than those managed by founders
33
Pyramids/groups and bad?
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Morck et al (2000): family firms in Canada (often in
pyramids) underperform similar Canadian and US
widely-held firms
Khanna and Rivkin (2001) on developing countries: in
the majority of countries group firms have higher ROA
Khanna and Palepu (2000) on India: benefits of
pyramids depend on degree of diversification in a
group (moderate diversification is bad)
Why in developing countries pyramids perform
better?
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Political connections are especially beneficial
Underdeveloped markets (relying on internal markets
have greater value)
34
Empirical evidence on expropriation of
small shareholders by families
Greater separation of control from cash flow
rights leads to lower market valuation (many
studies on different countries)
Firms in lower tiers of pyramids (i.e. where
separation of CR from CFR is larger) suffer from
“tunneling” – transfer of recourses to the apex
(Bertrand et al (2002) on India, Bae et al (2002)
on Korea)
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Holmen and Högfeldt (2002) do not find this for
Sweden
35
Why are control structures differ
across countries?
Legal environment.
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Weak protection of minority shareholders
(weak enforcement of property rights in
general) encourages concentration of control
Tax system
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taxation of intra-group dividends (US)
discourages pyramids
Openness of the economy
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Makes political connections less valuable
36
Russia. How do oligarch-controlled firms
perform compared to other firms? (Guriev
and Rachinsky (2004))
Regression analysis results:
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Total factor productivity growth of oligarch-controlled
firms is 8% higher on average (controlling for other
things)
This difference stems from a increase in output rather
than employment cuts
Perhaps oligarchs simply acquired assets with
faster productivity growth?
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No! Prior to 2002 productivity growth of oligarchcontrolled firms was not different from other
companies. Moreover, productivity levels were lower
Thus, it seems oligarchs took over poorly performing
firms and turned them around
37