Ownership Structure and Firm's Performance: Evidence from India

AuthorAman Srivastava
PositionAssociate Professor, Jaipuria Institute of Management, Noida, India
1. Introduction

Ownership structure of any company has been a serious agenda for corporate governance and that of performance of a firm. As a result, who owns the firm’s equity and how does ownership affect firm value has been a topic investigated by researchers for decades. The modern organization emphasizes the separation of management and ownership; in practice, the interests of group managing the company can vary from the interests of those that supply the capital to the firm. Corporate governance literature has devoted a immense attention to the ownership structure and performance of the firms. Shareholders of publicly held corporations are so numerous and small that they are not able to effectively control the decisions of the management team, and consequently cannot be certain that the management team represents their interests. Many solutions to this problem have been advanced, as stated before i.e. the disciplining effect of the takeover market, the positive incentive effects of the management shareholding stake and the benefits of large monitoring shareholders. A different problem, though, arises in firms with large controlling shareholders. As a large controlling shareholder has both the incentives and the power to control the management team's actions, management's misbehavior is a second order problem when such a large shareholder exists. As an alternative, the main problem becomes controlling the large shareholder's abuse of minority shareholders. In other words, holders of a majority of the voting shares in a corporation, through their ability to elect and control a majority of the directors and to settle on the outcome of shareholders' votes on other matters, have tremendous power to benefit themselves at the expense of minority shareholders. Thus, the type of owners as well as the distribution of ownership stakes will undoubtedly have an impact on the performance of firms. The large portion of the empirical literature studying the link between corporate governance and firm performance usually concentrates on a particular aspect of governance, such as board of directors, shareholders’ activism, compensation, anti-takeover provisions, investor protection etc.

The impact of ownership structure on firm performance has been extensively tackled in different developed markets and in recent times in emerging markets. In Indian context very few studies focused on this aspect. This paper is a moderate attempt to examine the relationship of ownership structure and performance of firms in India. The rest of the paper is organized as follows: Section 2 discusses on the literature review, where both theoretical and empirical studies on previous works are looked into. It also incorporates the corporate governance mechanism in India. In section 3, the methodology of this study is considered. Empirical results and discussions are made in section 4, while section 5 concludes the study.

2. Literature review

The firm’s equity and how does ownership affect firm value has been a topic investigated by researchers for decades; however, most of the studies in this context are conducted outside of India. The study failed to document any relevant study on the topic in Indian context. Fama and Jensen (1983 a & b) addresses the agency problems and they explained that a major source of cost to shareholders is the separation of ownership and control in the modern corporation. Even in developed countries, these agency problems continue to be sources of large costs to shareholders1.Demstez and Lehn (1985) argued both that the optimal corporate ownership structure was firm specific, and that market competition would derive firms toward that optimum. Because ownership was endogenous to expected performance, they cautioned, any regression of profitability on ownership patterns should yield insignificant results. Morck. (1988) by taking percentage of shares held by the board of directors of the company as a measure of ownership concentration and holding both Tobin’s Q and accounting profit as performance measure of 500 Fortune companies and using piece-wise linear regression, found a positive relation between Tobin’s Q and board ownership ranging from 0% to 5%, a negative relation for board ownership ranging from 5% to 25%, and again a positive relation for the said ownership above 25%. It is argued that the separation of ownership from control for a corporate firm creates an agency problem that results in conflicts between shareholders and managers (Jensen and Meckling, 1976). The interests of other investors can generally be protected through contractual arrangements between the company and concerned stakeholders, leaving shareholders as the residual claimants whose interests can adequately be protected only through the institutions of corporate governance (Shleifer and Vishny, 1997). Loderer and Martin (1997) analyzed the shareholding of insiders (i.e., director’s ownership) as a measure of ownership. Taking the said measure as endogenous variable and Tobin’s Q as performance measure, they found (through simultaneous equation model) that ownership does not predict performance, but performance is a negative predictor of ownership. Steen Thomsen and Torben Pedersen (1997) examine the impact of ownership structure on company economic performance in the largest companies from 12 European nations. According to their findings the positive marginal effect of ownership ties to financial institutions is stronger in the market-based

British system than in continental Europe. Cho (1998) found that firm performance affects ownership structure (signifying percentage of shares held by directors), but not vice versa. Jürgen Weigand (2000) found that (1) the presence of large shareholders does not necessarily enhance profitability, and (2) the high degree of ownership concentration seems to be a sub-optimal choice for many of the tightly held German corporations. Their results also imply ownership concentration to affect profitability significantly negatively. Their empirical evidence suggests that representation of owners on the board of executive directors does not make a difference. Yoshiro Miwa and Mark Ramseyer (2001) in their study of 637 Japanese firms and confirmed the equilibrium mechanism behind Demstez- Lehn. Demsetz and Villalonga (2001) examined the relation between the ownership structure and the performance (average Tobin’s Q for five years—1976-80) of the corporations if ownership is made multidimensional and also treated it as an endogenous variable. By using Ordinary Least Squares (OLS) and Two-stage Least Squares (2 SLS) regression model, they found no significant systematic relation between the ownership structure and firm performance. Lins (2002) examined whether management ownership structures and large non-management block holders are related to firm value across a sample of 1433 firms from 18 emerging markets. He finds that large non-management control rights block holdings (having more control rights) are positively related to firm value measured by Tobin’s Q. Michael L Lemmon and Karl V Lins (2003) used a sample of 800 firms in eight East Asian countries to study the effect of ownership structure on value during the region’s financial crisis. The crisis negatively impacted firm’s investment opportunities, raising the incentives of controlling shareholders to expropriate minority investors. The evidence is consistent with the view that ownership structure plays an important role in determining whether insiders expropriate minority shareholders. Using a sample of 144 Israeli firms, Beni Lauterbach and Efrat Tolkowsky (2004) find that Tobin's Q is maximized when control group vote reaches 67%. This evidence is strong when ownership structure is treated as exogenous and weak when it is considered endogenous. Christoph Kaserer and Benjamin...

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