Shareholder Protection: The Role of Multiple Large Shareholders

• Author: Raúl Barroso Casado,Michael Burkert,Daniel Oyon,Antonio Dávila
• DOI: http://doi.org/10.1111/corg.12131
• Date: 01 March 2016
• Published date: 01 March 2016

Shareholder Protection: The Role of Multiple

Large Shareholders

Raúl Barroso Casado*, Michael Burkert, Antonio Dávila and

Daniel Oyon

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: This paper addresses the effect of having multiple large shareholders on shareholder protection.

More specif‌ically,we examine to what extent this effectdepends on whether such largeshareholders are benef‌iciaryor f‌iduciary.

Research Findings/Insights: Analyzinglongitudinal, hand-collected data coveringSwiss listed companies, wef‌ind that having

several large shareholders leads to overall higher shareholder protection (i.e. adoption of more formal corporate governance

mechanisms).This is because large shareholders have an interest in putting moreformal governance mechanismsin place when

there is another large shareholder that might try to extract rents at the expense of others. Moreover, we f‌ind that this effect is

driven by the presenceof several benef‌iciary shareholders, i.e. shareholdersthat invest their own wealth in the companyin con-

trast to dispersed ownership and f‌iduciary shareholders, i.e. shareholders acting on behalf of others.

Theoretical/Academic Implications: Building on recentdevelopments in agency theory, thispaper contributes to the corporate

governance literature by empirically showing that potential “principal-principal”conf‌licts among large shareholders lead to

overall better shareholder protection in terms of more formal governance mechanisms being adopted. This f‌inding contrasts

with situations in which there is only one large shareholder that does not have an interest in strengthening formal corporate

governance. Our f‌indings imply, however, that the characteristics of the large shareholders matter: Fiduciary shareholders in

the Swiss setting are mostly passive buy-and-hold shareholders and therefore do not engage extensively in improving share-

holder protection. Benef‌iciary shareholders, in contrast, directly intervene in the governance of the f‌irm (i.e. governance by

voice), so that in the presence of multiple benef‌iciary shareholders, more formal governance mechanisms help tomonitor not

only management but the other large shareholders as well. In addition, more formal governance mechanisms serve as a plat-

form to coordinate their diverging objectives.

Practitioner Implications: We demonstrate the inf‌luenceof a second (or several) large benef‌iciary shareholder(s), on corporate

governance and the benef‌it to all shareholders. In addition, we propose thestrengthening of governance mechanisms as a plat-

form to reconcile conf‌licting interests among prominent shareholders and contribute to the debate on the allocation of certain

voting privileges to long-term shareholders.

Keywords: Corporate Governance, Shareholder Protection, Multiple Shareholders, Principal-Principal Conf‌lict, Share-

holder Types

INTRODUCTION

Research on shareholder protectionhas shown that owner-

ship concentration of a single largeshareholder is a defen-

sive measure for shareholders when the legal context is not

favorable, as in continental Europe (La Porta, Lopez-de-Silanes,

& Shleifer, 1999). The remaining shareholders, however, may suf-

fer the consequences of such a concentration as the large share-

holder is in a good position to make the management act in his

interests at the expense of the other smaller (i.e,, less powerful)

shareholders. We study, in the context of relatively low

shareholder protection, how conf‌licts among several large share-

holders play an important role in the adoption of formal corpo-

rate governance mechanisms that protect all investors. We build

on a growing body of literature addressing situations in which

several large shareholders co-exist (Connelly,Hoskisson, Tihanyi,

& Certo, 2010a; Wiseman, Cuevas-Rodríguez, & Gomez-Mejia,

2011). Such an analysis is vindicated, as prior literature focuses

mainly on situations when there is only one large shareholder

and many small shareholders in place (for an overview, see

Connelly et al., 2010a; and Edmans, 2014). The presence of multi-

ple large shareholders and its consequences on shareholder pro-

tection has, however, been largely overlooked by prior research

(Mishra, 2011). Yet, more than 35 percent of European f‌irms

(Laeven & Levine, 2008), and more than 47 percent

1

of the f‌irms

in our sample, have not one, but multiple large shareholders.

*Addressfor correspondence:Raúl Barroso Casado,IESEG, 1 Parvis de la Défense, 92044

Paris, France.Tel: +33155911010; E-mail:r.barrosocasado@ieseg.fr

© 2015 JohnWiley & Sons Ltd

doi:10.1111/corg.12131

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Corporate Governance: An International Review, 2016, 24(2):105–129

Addressing this research gap, we theorize and test the

effects of having at least two large shareholders (e.g., family

and private equity) on shareholder protection. We thereby

take as a proxy for shareholder protection the number of vol-

untarily adopted formal corporate governance mechanisms

that were proposed by the Swiss Code of good governance.

While previous research suggests that having only one large

shareholderwill lead to fewer formalgovernance mechanisms

being adopted, we argue that the heterogeneous interests of

different powerful shareholders lead to the adoption of more

formal corporategovernance mechanisms and hence to stron-

ger, rather than weaker, shareholder protection.

We build on agency theory (Jensen & Meckling, 1976;

Shleifer& Vishny,1986, 1997), arguing thatownership concen-

tration leads, on average, to lower shareholder protection

(Doidge, Karolyi,& Stulz, 2007) in terms of formal governance

mechanisms being adopted. Then we address thewell-placed

critique that research to date has theoretically and empirically

focused on ownership structures that are either characterized

by 100 percent small shareholders or by situations with one

large and many small shareholders (Laeven & Levine, 2008).

Going beyond this common setting, we argue theoretically

that having not one but at least two large shareholders is an

effective way to mitigate the risk of expropriation from the

other large shareholder (“principal-principal”conf‌lict). Thus,

we expect that the presence of multiple large shareholders

leads to highershareholder protection, thatis, we expect com-

panies with more than one large shareholder to adopt more

formal corporate governance mechanisms. We argue that the

adoption of a larger number of formal corporate governance

mechanisms is not only a means to monitor the other large

shareholder(s), but also helps to reconcile their diverging

interests.

In order to provide further evidence for the suggested rela-

tionship between the number of large shareholders and the

formal corporate governance mechanisms adopted, we

hypothesize that the characteristics of these shareholders

plays an important role for shareholder protection. We def‌ine

benef‌iciary shareholders as individuals or institutions that

invest their own wealth in a given f‌irm. This includes family

f‌irms, but also private equity investors. Such shareholders

are directlyinvolved in the management or direct supervision

of the f‌irm and intervene directly in its governance. This is

referred to as governance by voice (Edmans, 2014). Fiduciary

shareholders include those companies with dispersed owner-

ship managed by professional managers who invest other

people’s wealth. This category includes banks, corporations,

government, and pension funds. In the Swiss context, such

investors are known to represent more passive buy-and-hold

investors (Ruigrok, Peck, & Keller, 2006). It is reasonable to

assume that in situations where several “active”benef‌iciary

shareholders are involved, “principal-principal”conf‌licts are

more likely to arise than in situations with several passive

f‌iduciary shareholders. We therefore expect the effect on

shareholder protection of severalof these more passive share-

holders to be substantially weaker.

To test these predictions, we analyze a hand-collected

dataset covering Swiss listed companies over a nine-year

period (2002–10). The database starts in 2002 when the Swiss

code of good governance (“Swiss Code”hereafter) was

issued. Economiesuisse, an employerassociation representing

the interests of the most important organizations and indus-

tries in the country, put together this Code. The adoption of

the Swiss Code is mandatory for listed companies, but with

the discretion to implement, or not to implement, the recom-

mended formal corporate governance mechanisms. This situ-

ation contrastswith that of countries such as the UnitedStates,

Germany, and France, where many of these mechanisms are

legally imposed on corporations (Enriques & Volpin, 2007),

or companies were at least required to explain why they did

not implement a certain mechanism (“comply or explain”)

(Luo & Salterio, 2014). We follow La Porta et al. (1999)to clas-

sify a shareholderas a “large share holder”when ownershipis

more than 5 percent of the voting rights. We then categorize

them into family, banks, corporations, government and pen-

sion funds, plus an additional category, which includes pri-

vate equity. We use the adoption of ten corporate

governance mechanisms (for which adoption can be unam-

biguously measured), as a proxy for shareholder protection.

Our data reveal signif‌icant differences in shareholder pro-

tection in terms of thenumber of corporate governance mech-

anisms adopted. Our baseline results support previous

researchshowing that ownership concentrationleads to lower

shareholder protection (Doidge et al., 2007) and thus a higher

risk of rent extraction at the expense of small shareholders.

More importantly, we provide empirical support for our cen-

tral theoretical reasoning that having more than one large

shareholderin place is associated with better shareholder pro-

tection, that is, we f‌ind that having two or more large share-

holders in place leads to the adoption of a higher number of

governance mechanisms. Further, we show that if these two

or more shareholders are benef‌iciary, these effects are signif‌i-

cantly higher. To better understand these results, we test for

the possibility that two or more large shareholders may form

a coalition to extractrents from the other,smaller shareholders

(Laeven & Levine, 2008). However, we do not f‌ind evidence

either for the coalition argument or for any signif‌icant

governance by exit either through the threat of exit (Edmans,

Fang, & Zur, 2013) or eventually by selling their stocks

(Edmans, 2014).

These results are also relevant from a practical perspective.

Specif‌ically, wepropose the inf‌luence of a second largebenef‌i-

ciary shareholder,or any other shareholder that actively inter-

venes, as a corporate governance mechanism. Because of the

risk of rent extraction from each other, both largeshareholders

may have an interest in reducing any “principal-principal”

conf‌lict by putting in place more formal governance

mechanisms. This in turn improves overall shareholder

protection. Furthermore, the f‌indings suggest a vision of

corporate governance mechanisms beyond its traditional

monitoring function. Agency conf‌licts may be mitigated with

better governance mechanisms reducing moral hazard and

adverse selection (Eisenhardt, 1989). These formal corporate

governance mechanisms, however, also provide a formal

framework to coordinate and reconcile the diverginginterests

of the large shareholders, as suggested by Edmans and

Manso (2011).

We organize the paper as follows: The next sectionpresents

the hypothesesand theoretical development.The third section

outlines the background and describes the specif‌icinstitu-

tional context. The fourth section presentsthe research design

and data, the f‌ifth section, the results of hypotheses testing,

106 CORPORATE GOVERNANCE

© 2015 JohnWiley & Sons LtdVolume 24 Number 2 March 2016