Are All Private Benefits of Control Ineffective? Principal–Principal Benefits, External Governance Quality, and Firm Performance

• DOI: http://doi.org/10.1111/joms.12420
• Author: Marc van Essen,Pursey P. M. A. R. Heugens,Steve Sauerwald,Roxana Turturea
• Date: 01 June 2019
• Published date: 01 June 2019

© 2018 John Wiley & Sons Lt d and Society for the Adva ncement of Management Stud ies

Are All Private Benefits of Control Ineffective?

Principal–Principal Benefits, External Governance

Quality, and Firm Performance

Steve Sauerwalda, Pursey P. M. A. R. Heugensb,

Roxana Turtureac and Marc van Essend,e

aUniversity of Ill inois at Chicago; bEras mus University; cAalto Uni versity; dUniversity of South Caroli na;

eEMLYON B usiness School

ABST RACT Private benef its of control (PBC) are benefits t hat controlling shareholders con-

sume, but that are not shared w ith minority shareholders. Research foc using on the value

protection role of corporate governa nce typically frames PBC a s principal–principal ( PP)

agency costs, and i nterpret s them as a form of minority shareholder expropriat ion that

decreases f irm performance. Taking a value creat ion perspect ive of corporate governance,

however, we propose a more nuanced role for PBC. Specif ical ly, we see them also a s PP agency

benefits that c ompensate control ling shareholders for their monitoring and adv isory services,

which can increa se firm performance. Since bot h PP costs and benefits affect f irm perfor-

mance, we theorize t hat PBC enhance firm per formance at a d iminishing rate. Fur thermore,

we show that the effect of PBC on f irm performance is more positive when count ry-level

external govern ance mechanisms are strong.

Keywo rds: control transactions, comparative corporate governance, controlling

shareholders, inst itutions , firm performance, privat e benefits of control

INTRODUCTION

In many parts of the world, controlling shareholders privately enjoy benefits not shared

with minority shareholders (Dharwadk ar et al., 2000; Dyck and Zingales, 2004; Young

et al., 2008). In a narrow interpretation of corporate governance that emphasizes the

value protection role of corporate governance (Shleifer and Vishny, 1997), private ben-

efits of control (PBC ) are overwhelmingly conceived as the result of an agency con flict

Journal of Man agement Studi es 56:4 June 2019

doi: 10.1111 /jom s.12 420

Address for re prints: Steve Sauerwa ld, Department of Manag erial Studies, Univers ity of Illinois at Chica go,

601 South Morgan Str eet, 2210 Univers ity Hall, Chicago, I L 60607-1722, USA (ssauer w@uic.edu).

726 S. Sauerwald et al.

© 2018 John Wiley & Sons Lt d and Society for the Adva ncement of Management Stud ies

between controlling and minority shareholders, also cal led the principal–principal (PP)

agency problem (Young et al., 2008). Viewed through this va lue protection lens, PBC

are an expression of PP agency costs t hat reduce shareholder wealth a nd firm profitabil-

ity. Direct PP costs refer to fina ncial r esources controll ing shareholders appropriate that

can no longer be used to advance fi rm performance (Gilson, 2006; Johnson et al., 200 0).

For instance, controlling shareholders may misuse corporate resources by transferring

assets and profits out of f irms via tra nsfer pricing, subsidizing personal loan s, higher

compensation for executive or supervisory roles they perform, perk s such as the use of

corporate jets for personal use, and even outright theft. Ind irect PP costs stem from the

misalig nment between the incentives of control ling owners and those of minority share-

holders. Because controlling shareholders often have a less diversi fied investment port-

folio, they tend to push for less risky strategies in t he firms they control (Gomez-Mejia

et al., 2003; Wright et al., 1996). This may result in the prevention of value-creat ing

takeovers (Li a nd Qian, 2013), and the pursuit of ineffective invest ment decisions (Ward

and Filatotchev, 2010).

While we acknowledge these negative effects of PBC, we also stress a positive side

of PBC that emphasizes a broader value creation perspective of corporate governance

(Filatotchev et al., 2006; Zahra et al., 2009). First, we propose that PBC are the ‘price’

minority shareholders pay for the valuable managerial control and advisory services ren-

dered by the controlling shareholder (Gilson and Schwartz, 2013; Pacces, 2012). These

monitoring and advisory services come at private costs to the controlling shareholder,

such as efforts and under-diversification. Private benefits compensate the controlling

shareholder for these private costs (Enriques et al., 2014). Second, we argue that PBC

provide incentives for the controlling shareholder to engage in entrepreneurial opportu-

nity recognition, a ‘process through which [they] identify meaningful patterns in complex

arrays of events or trends’ (Baron and Ensley, 2006, p. 1331; Shane and Venkataraman,

2000). Controlling shareholders are often invested in multiple companies simultaneously,

and thus may develop opportunity recognition templates that are ‘more clearly defined,

richer in content, and more concerned with factors and conditions related to (…) gener-

ation of positive cash flow’ (Baron and Ensley, 2006, p. 1331; Holderness, 2003; Pacces,

2012). When engaging in this value creation role, controlling shareholders may seek to

extract an amount of PBC that is large enough to serve as an incentive for their oppor-

tunity recognition efforts, but small enough to entail limited consequences for firm per-

formance. After all, when the firms they control perform well, the magnitude and range

of private benefits controlling shareholders can enjoy widens as well. In sum, while PBC

are by definition not shared, PP benefits frequently do have an indirect positive effect on

firm performance. By putting a private premium on control, advice, resource provision,

and opportunity recognition activities, PBC encourage controlling owners to curb man-

agerial opportunism and to initiate and support growth-oriented initiatives, which create

shared benefits for all shareholders by improving firm performance (Zahra et al., 2009).

We do not, however, expect PP costs and benefits to accumulate in equal measure

across the entire PBC spectrum. Specifically, while we expect the relationship between

PBC and firm performance to be positive, we expect performance benefits to accrue with

PBC at a diminishing rate (Gilson and Gordon, 2003). PP benefits tend to accumulate

Are All P rivate Benefits of Control Ineffective? 727

© 2018 John Wiley & Sons Lt d and Society for the Adva ncement of Management Stud ies

already in the lower ranges of the PBC spectrum due to the incentives provided to con-

trolling owners. However, in the higher ranges of the spectrum we propose that PP costs

will begin to cancel out PP benefits. Specifically, when PBC become excessively high,

minority shareholders may perceive them as unfair, or disproportionately large com-

pared to the benefits brought to the table by controlling shareholders. This may result

in internal conflicts between minority and controlling shareholders that could negatively

affect firm performance. Even when controlling owners want to pursue entrepreneurial

opportunities, they may have too few resources to realize such opportunities, because

too many resources are converted into PBC. PP costs will therefore materialize predom-

inantly and increasingly in the higher ranges of the PBC spectrum.

Our theory generalizes well, but it is not universal. PBC differ substantially across

countries (Dyck and Zingales, 2004; Nenova, 2003). We direct attention to the quality of

country-level external governance institutions as a potential contingency (Aguilera et al.,

2015; Sauerwald and Peng, 2013). Specifically, we expect that the relationship between

PBC and firm performance will be more positive in countries with strong external cor-

porate governance mechanisms (such as effective rule of law or shareholder protection),

because these mechanisms help protect the wealth of minority shareholders while leav-

ing controlling owners’ incentives to enhance firm performance largely intact (Aguilera

et al., 2008).

An inherent difficulty in measuring PBC is their unobservable nature (Albuquerque

and Schroth, 2010; Burkart et al., 2000; Dyck and Zingales, 2004). Various measurement

approaches exist, centring either on price differentials between voting and non-voting

dual-class stock (Nenova, 2003) or on the premiums paid for control block transactions

(Barclay and Holderness, 1989; Dyck and Zingales, 2004). The block premium strategy,

which builds on the price differentials between the share price for the control block,

and the share price on the stock exchange, is often seen as the preferred method, as it

also applies to firms that did not adopt dual class shares (Nenova, 2003) and to firms

incorporated in countries where dual class shares are illegal (Dyck and Zingales, 2004).

Conceptually, a positive block premium conveys the expectations of the new controlling

owner in terms of how much PBC he or she will be able to extract. The higher the pre-

mium a new owner is willing to pay for gaining control over a firm, the higher the PBC

he or she predicts to extract later on. We therefore opt for the block premium approach

and estimate PBC by compiling a comprehensive sample of up to 962 control transac-

tions, materializing between 1990 and 2016 in 57 countries around the globe.

Our study makes two contributions. First, we introduce the notion of PP benefits –

shareholder value created by controlling owners through their provision of shareholder

benefiting services in the areas of control, advice, resource provision, and the implemen-

tation of entrepreneurial opportunities. This concept complements our already robust

understanding of PP costs – which is grounded in the narrow value protecting view of

corporate governance (Li and Qian, 2013; Singla et al., 2014) – with a broader value

creation view of corporate governance (Zahra and Filatotchev, 2004). Under this view,

minority shareholders may be willing to accept a moderate level of PBC in exchange

for the commitment of controlling shareholders. Our study supports the contention that