Turf war or collusion: An empirical investigation of conflict of interest between large shareholders

• Author: Zhonghui “Hugo” Wang
• Published date: 01 September 2017
• DOI: http://doi.org/10.1111/corg.12207
• Date: 01 September 2017

ORIGINAL ARTICLE

Turf war or collusion: An empirical investigation of conflict of

interest between large shareholders

Zhonghui “Hugo”Wang

University of North Carolina‐Greensboro,

United States

Correspondence

Zhonghui “Hugo”Wang, Bryan School of

Business and Economics, University of North

Carolina at Greensboro, PO Box 26170,

Greensboro, NC 27402, USA

Email: zhonghui‐wang@uncg.edu

Abstract

Manuscript Type: Empirical

Research Question/Issue: Does the smaller blockholder monitor or collude with a larger

counterpart in a two‐blockholder firm? Does the larger blockholder prefer not to share private

benefits with the smaller blockholder or partially yield control to the smaller counterpart in a

coalition? What are the contingent factors that influence the conflict of interest among large

shareholders?

Research Findings/Insights: In two‐blockholder firms, the voting power of the larger

blockholder negatively impacts the presence of the cumulative voting rule, even if the rule is pos-

itively associated with firm value and provides the smaller blockholder a better opportunity to

elect directors despite the competition from the larger blockholder. Voting power concentration

negatively impacts the adoption of the cumulative voting rule in two‐blockholder firms. The more

voting power a smaller blockholder can employ to contest the largest blockholder, the more likely

the two‐blockholder firm will observe the cumulative voting rule. Two‐blockholder firms are more

likely to observe the cumulative voting rule when a coalition of blockholders has voting power

that falls far below a threshold that warrants control of the firm.

Theoretical/Academic Implications: The empirical analysis of the paper suggests that the

larger blockholder is willing to defend the control of the firm andthe ability to pursue private ben-

efits at the cost of firm value. The smaller blockholder is more likely to yield to the power of the

larger blockholder and choose to collude rather than compete with the largest blockholder. The

motivation and ability of a smaller blockholder to monitor the larger blockholder is contingent

upon the voting power balance of the two blockholders.

Practitioner/Policy Implications: Minority investors should be alert to potential collusion

among large shareholders. Regulators should consider enforcing the cumulative voting rule more

widely to facilitate shareholder democracy and improve firm value.

KEYWORDS

Corporate Governance, Conflict of Interest, Multiple Blockholders, Collusion, Voting Rule

1|INTRODUCTION

While many US firms have multiple large shareholders (Dlugosz,

Fahlenbrach, Gompers, & Metrick, 2006), existing studies of

principal–principal conflict focus on the conflict between one large

shareholder and many small ones (e.g., Villalonga & Amit, 2006).

Empirical research of the conflict of interest among multiple large

shareholders is still limited and center on the connection between

ownership structure and firm value (e.g., Attig, El Ghoul, & Guedhami,

2009; Barroso Casado, Burkert, Dávila, & Oyon, 2016; Cai, Hillier, &

Wang, 2016; Hu & Izumida, 2008; Jara‐Bertin, López‐Iturriaga, &

López‐de‐Foronda, 2008; Konijn, Kräussl, & Lucas, 2011; Laeven &

Levine, 2008; Lehmann & Weigand, 2000; López‐Iturriaga &

Santana‐Martín, 2015; Maury & Pajuste, 2005; Mishra, 2011; Santos,

Moreira, & Vieira, 2014). Prior theoretical analyses suggest that smaller

owners can either monitor or collude with the controlling one (e.g.,

Bennedsen & Wolfenzon, 2000; Pagano & Röell, 1998; Zwiebel,

1995). Yet, few, if any, prior empirical studies examine a real‐world

Received: 28 January 2016 Revised: 1 March 2017 Accepted: 3 March 2017

DOI: 10.1111/corg.12207

358 © 2017 John Wiley & Sons Ltd Corp Govern Int Rev. 2017;25:358–380.wileyonlinelibrary.com/journal/corg

setting in which smaller blockholders either monitor or collude with

the controlling shareholder.

This empirical oversight renders some important and interesting

questions unanswered. Without identifying a situation in which the

interest of the largest blockholder diverges from that of smaller

blockholders, empirical studies can only speculate rather than confirm

whether smaller blockholders monitor or collude with the largest

shareholder (Cai et al., 2016; Laeven & Levine, 2008; Maury & Pajuste,

2005). Moreover, it is difficult to empirically disentangle the impact of

smaller blockholders from that of the largest owner. Consequently, it is

difficult to answer the following questions: Does a second largest

shareholder monitor or collude with the largest one? Does the largest

blockholder prefer not to share private benefits with a smaller

blockholder or partially yield control to a smaller counterpart in a

coalition? What are the contingent factors that influence the conflict

of interest among large shareholders?

This paper tries to address these questions by building upon prior

theoretical models (Bennedsen & Wolfenzon, 2000; Pagano & Röell,

1998; Zwiebel, 1995) and empirical studies (e.g., Cai et al., 2016; Maury

& Pajuste, 2005) to examine how conflicts among large blockholders

impact firms’governance choices and value in the unique empirical

setting of the cumulative voting rule (Gompers, Ishii, & Metrick, 2003).

The cumulative voting rule, as a vote‐casting method, has long

been recognized by law and finance scholars as influential in board

elections (Bhagat & Brickley, 1984; Chen, Li, & Lin, 2015; Glazer,

Glazer, & Grofman, 1983). The rule is still relevant today: At least 5.7

percent of 1500 large US firms traded on the New York Stock

Exchange (NYSE) and NASDAQ followed the rule in 2012 (source:

Wharton Research Data Services), either voluntarily or under state

regulations; as of 2016, 18 of the 50 US states make the rule either

a mandatory choice or a default option (see Appendix 1). More

importantly, the rule should positively impact firm value when small

shareholders capitalize on the rule to elect their representatives as

directors who may help their constituencies deter large owners from

pursuing private benefits that hurt the firm.

Consequently, the cumulative voting rule naturally elicits

conflict of interest between large and small blockholders, each with

at least 5 percent ownership. Under the cumulative voting rule and

the one share–one vote regime (Grossman & Hart, 1988), every

shareholder's total votes are the product of the number of shares

they own and the number of directors to be elected. Shareholders

can allocate all their votes for a single candidate or distribute votes

among multiple candidates in any manner (Gompers et al., 2003).

For example, let us assume that a firm with 100 total shares has

shareholder A who owns 51 shares and shareholder B who

possesses 26 shares. When the firm needs to elect two directors,

shareholder A with 51 shares would control the election without

the cumulative voting rule. When the rule is followed, a shareholder

B with 26 shares can concentrate all her 52 (26 × 2) votes to

successfully elect her choice of candidate. Although shareholder A

has 102 total votes (51 × 2), she cannot guarantee the election of

both her candidates because she has only 50 votes left for one of

the candidates if she wants to ensure the election of the other

candidate with 52 votes. Therefore, conflict of interest emerges

because the cumulative voting rule weakens the largest

blockholder's ability to control board election and provides better

chances for a smaller blockholder to elect her favored candidate

despite the opposition of the largest shareholder.

By investigating US firms with two blockholders that were traded

on NYSE and NASDAQ between 1997 and 2002, this paper has the

following findings: The cumulative voting rule is positively associated

with firm value. Yet, the voting power of the largest blockholder

negatively impacts the presence of the cumulative voting rule. Firms

with more concentrated voting power are less likely to follow the

cumulative voting rule. The more voting power the smaller

blockholder has in comparison with the larger blockholder, the more

likely the firm will observe the cumulative voting rule. Firms are more

likely to observe the cumulative voting rule when the total voting

power of blockholders falls far below a threshold that warrants

control of the firm.

This study contributes to the research of conflicts among multiple

blockholders both theoretically and empirically. Theoretically, this

study offers evidence that helps settle prior debates. For example, it

effectively confirms Pagano and Röell (1998)'s argument that the

larger blockholder prefers not to share private benefits with her

smaller counterpart. It also offers evidence that is consistent with

Bennedsen and Wolfenzon (2000)'s prediction that small blockholders

would prefer to collude with than monitor the largest blockholder.

Empirically, this paper extends the scant finance literature on the

conflicts among multiple large shareholders and their impact on firm

value (Laeven & Levine, 2008; Maury & Pajuste, 2005). It

demonstrates how conflict of interest among multiple large

shareholders arises, highlights the contingent factors that impact the

conflict and shape large blockholders’attitude towards governance

choices, and provides evidence showing how blockholders influence

firm value with their governance choices.

2|THEORY AND HYPOTHESES

2.1 |Large and small blockholders: Contest or

collusion

As prior literature suggests that a controlling shareholder has the

incentive and ability to expropriate small shareholders (Shleifer &

Vishny, 1997), existing theoretical analyses of firms with multiple large

shareholders argue that smaller blockholders can either monitor the

controlling blockholder to prevent expropriation (Pagano & Röell,

1998) or collude with the controlling owner in expropriating other

shareholders (Bennedsen & Wolfenzon, 2000). Specifically, Pagano

and Röell (1998) propose two important arguments. First, smaller

blockholders can monitor a controlling shareholder and potentially

deter the large owner from pursuing private benefits. Second, a small

blockholder can free‐ride the monitoring of the larger blockholder

either because the larger owner has stronger incentive and capability

of monitoring managers or because the small blockholder would

consider the monitoring costs that the blockholder sustains a waste.

Bennedsen and Wolfenzon (2000) argue that multiple large

shareholders can form different types of coalitions which have two

types of impacts on the firm. First, when multiple large shareholders

WANG 359