Effect of Governance Reforms on Corporate Ownership in Italy: Is It Still Pizza, Spaghetti, and Mandolino?

• Author: Elena Sapienza,Federica Pazzaglia,Stefano Mengoli
• Date: 01 September 2009
• DOI: http://doi.org/10.1111/j.1467-8683.2009.00752.x
• Published date: 01 September 2009

Effect of Governance Reforms on Corporate

Ownership in Italy: Is It Still Pizza, Spaghetti,

and Mandolino?

Stefano Mengoli, Federica Pazzaglia, and Elena Sapienza

ABSTRACT

Manuscript Type: Empirical.

Research Question/Issue: This paper describes the logic that guides the implementation of corporate governance reforms

and investigates the extent to which the logic leads to an increase in investor protection. We use the example of Italy, where

major governance reforms were passed in 1998 to protect minority shareholders from the risk of expropriation.

Research Findings/Insights: Our two-stage mixed-methods longitudinal study (1995–2005) reveals that the reforms were

only modestlyeffective in improving governance practices. On the one hand, we document a greateralignment of cash f‌low

rights and voting rights of ultimate owners after 1998, suggesting that minority shareholders face lower risk of expropria-

tion. Yet, on the other hand, we f‌ind that the percentage of f‌irms where control is fully contestable continues to remain low.

Our qualitative analysis reveals both facilitators such as institutional investor activism and mandatory provisions, and

impediments such as discretionary provisions, weak enforcement, and an ingrained culture of high control.corg_752629..645

Theoretical/Academic Implications: This study elaborates extant theory on the effectiveness of reforms by adopting a

longitudinal design that describes both their underlying logic and their actual effects on business practices. It also offers

conceptual clarity to this literature by bringing attention to factors that act as facilitators and impediments to reform efforts.

Practitioner/Policy Implications: This study prompts lawmakers in countries endeavoring reforms to encourage partici-

pation of institutional investors, as also urges them to consider mandatory provisions, especially those which enhance

disclosure and representation.

Keywords: Corporate Governance, Ownership Structure, Regulation, Italy

INTRODUCTION

This paper describes the logic that guides the implemen-

tation of governance reforms and investigates the extent

to which these logics lead to an increase in protection of

minority shareholders from the risk of expropriation by con-

trolling shareholders. Several recent studies have linked the

risk of expropriation faced by minority shareholders in

countries characterized by poor investor protection to dif-

ferences between cash f‌low rights and voting rights held by

controlling shareholders (e.g., Johnson, La Porta, Lopez de

Silanes, & Shleifer, 2000; Shleifer & Vishny, 1997). Wide dif-

ferences between cash f‌low rights and voting rights are

quite pervasive across several countries with f‌ive out of 13

Western European countries exhibiting substantial separa-

tion of cash f‌low rights and voting rights (Faccio & Lang,

2002). Similar trends have been reported forAsian countries,

including China, India, and South Korea (Claessens,

Djankov, & Lang, 2000; Khanna & Palepu, 2000). Extreme

examples of separation include the Agnelli family in Italy

who own 9 per cent of Unicem but have 47 per cent of the

voting rights; the Eriksson family in Sweden who own 1.5

per cent of Realia, but have 8.7 per cent of voting rights; and

Mr. Peter Munk in Canada who owned 7.3 per cent of

Horsham as its CEO, but had 79.7 per cent of voting rights

(Faccio & Lang, 2002; La Porta, Lopez de Silanes, & Shleifer,

1999).

The separation of cash f‌low rights and voting rights is

generally achieved through the use of pyramidal structures

and/or dual classes of shares. La Porta, Lopez-de-Silanes,

and Shleifer (1999) show that over 30 per cent of listed f‌irms

Please contact authors at stefano.mengoli@unibo.it, federica.pazzaglia@ucd.ie, or

elena.sapienza@unibo.it

629

Corporate Governance: An International Review, 2009, 17(5): 629–645

© 2009 Blackwell Publishing Ltd

doi:10.1111/j.1467-8683.2009.00752.x

in Austria, Belgium, France, Germany, Hong Kong, Israel,

Italy, New Zealand, Singapore, South Korea, Spain, and

Sweden are characterized by a combination of concentrated

ownership and pyramidal structures. They also document

that f‌irms in Denmark, Finland, Germany, Italy, Mexico,

Netherlands, Norway, Sweden, and Switzerland present

dual classes of shares. In contrast, while 21 per cent of family

f‌irms in the US present dual-classes of shares, pyramiding is

almost absent (Villalonga & Amit, 2008).

As investors’ conf‌idence in f‌inancial markets is the main

driver of economic growth (Shultz, 2005), several countries

characterized by poor investor protection have recently

introduced governance reforms (Gilson, 2001). These

reforms have primarily been inspired by the Anglo-Saxon

governance system as it arguably grants better investor pro-

tection through the specif‌ication of the rights of outside

investors and the quality of their enforcement (La Porta,

Lopez de Silanes, Shleifer, & Vishny, 1997, 1998). How-

ever, prior studies remain inconclusive on the extent to

which governance reforms are effective. For example, while

reforms have been found to be quite effective in countries

such as Argentina, Germany, and Greece, they have been

found to be less effective in countries such as Cyprus, China,

and Russia (e.g., Apreda, 2001; Cromme, 2005; Jesover,2001;

Judge & Naoumova, 2004; Krambia-Kapardis & Psaros, 2006;

Tsipouri & Xanthakis, 2004; Werder, Talaulicar, & Kolat,

2005; Zhang, 2007).

We develop the argument that greater attentiveness to

the logic guiding the implementation of reforms would

enable a more precise identif‌ication of their facilitators and

impediments, and in turn enhance our understanding of

why some reforms efforts succeed while others fail. While a

discussion of factors that serve as facilitators and impedi-

ments is implicit in some prior studies (e.g., Krambia-

Kapardis & Psaros, 2006; Solomon, Solomon, & Young-Park,

2002), further clarity on their identity and ability to affect

the successful implementation of reforms is needed. Thus

far, traditional national culture has been argued to be an

impediment in countries such as South Korea, Cyprus, and

Turkey (Ararat & Ugur, 2003; Krambia-Kapardis & Psaros,

2006; Liew, 2007; Solomon et al., 2002), while weak enforce-

ment (Enriques & Volpin, 2007; Jesover, 2001; Zhang, 2007)

and the complexity of the content of reforms have been

argued to be major impediments in other contexts such as

Germany (Nowland, 2008; Werder, Talaulicar, & Kolat,

2005). However, the literature also presents a few areas of

disagreement regarding the ability of individual factors

to affect the successful implementation of reforms. For

example, while some studies have identif‌ied institutional

investors as key facilitators in Turkey and Malaysia (Ararat

& Ugur, 2003; Liew, 2007; Solomon et al., 2002), Zhang

(2007) f‌inds them to be ineffective in changing governance

practices in China. We argue that there are two possible

reasons behind these disagreements. First, the discussion of

facilitators and impediments has mostly been a secondary

focus of previous studies, often as part of speculative con-

clusions to support their results. And second, there has

been a tendency to singularly focus on individual factors

without explicitly considering how they may trigger, rein-

force, or weaken each other. For example, one could argue

that the effectiveness of institutional investor activism

might be affected by the level of enforcement and the pres-

ence of disclosure requirements.

The above state of the literature motivates our investiga-

tion of the effect of the 1998 corporate governance reform

(Draghi Law) in Italy on the separation of cash f‌low rights

and voting rights of listed f‌irms. We consider the period

1995–2005 in order to take into account both prior and sub-

sequent practices. The goal of our study is both theory

testing and theory elaboration. We test extant theory by

investigating the ability of corporate governance reforms to

shape business practices. This investigation stems from the

often contradicting evidence provided by the studies on

the topic. Unlike previous studies, we use a longitudinal

research design, which we argue is more appropriate to

study changes in business practices as a result of changes in

regulation as it allows the incorporation of how events

unfold over time. As also, we elaborate extant theory on the

ability of governance reforms to shape business practices by

drawing attention to the logic by which particular regimes

attempt to implement contested governancepractices and to

the facilitators and impediments of reforms. To the best

of our knowledge, this is among the few studies that inves-

tigate the underlying logic of reforms and adopts a longi-

tudinal design to examine this phenomenon outside the

US.

Italy presents an excellent setting to analyze the effective-

ness of governance reforms as Italian f‌irms have been his-

torically prone to poor corporate governance practices with

specif‌ic reference to the misalignment of cash f‌low rights

and voting rights (Faccio & Lang, 2002; Johnson et al., 2000;

Volpin, 2002). Additionally, several scholars have

documented that the low protection of Italian minority

shareholders allows controlling shareholders to extract a

considerable amount of private benef‌its (e.g., Bigelli and

Mengoli, 2004; Bigelli, Mehrotra, & Rau, 2007; Zingales,

1994). As also, it has been argued that the high benef‌its of

control explain the gap between the value of voting and

non-voting shares in Italy, as well as the large control

premium paid in takeovers (Dyck & Zingales, 2004; Nenova,

2003; Zingales, 1994). To increase minority shareholders’

conf‌idence in the f‌inancial market, Italy went through

reforms, a principal one being the 1998 corporate gover-

nance reform (Draghi law). Thus, a study of the 1998 reform

and its effect on governance practices showcases itself as a

“natural corporate governance experiment” (Denis & Mc

Connell, 2003).

Our two-phase mixed-methods study reveals that the

reforms were only partially successful. Areas of improve-

ment triggered by the reforms include an increase in disclo-

sure by listed f‌irms, increased representation of minority

shareholders on assemblies, and a better alignment of cash

f‌low rights and voting rights. However, the reforms were

unsuccessful either at reducing ownership concentration, or

at increasing the percentage of f‌irms where control is fully

contestable. Thus, small shareholders can be dominated

by large shareholders even post-reform as the controlling

majority continues to outvote the minority. The difference

post-reform is that minority shareholders may know this in

advance and oppose transactions that may be harmful and

attribute lower valuations to f‌irms with poor governance

practices.

630 CORPORATE GOVERNANCE

Volume 17 Number 5 September 2009 © 2009 Blackwell Publishing Ltd