Blockholder leverage and payout policy: Evidence from French holding companies

• Author: Douglas V. DeJong,Sereeparp Anantavrasilp,Ulrich Hege,Abe Jong
• Published date: 01 January 2020
• DOI: http://doi.org/10.1111/jbfa.12415
• Date: 01 January 2020

DOI: 10.1111/jbfa.12415

Blockholder leverage and payout policy: Evidence

from French holding companies

Sereeparp Anantavrasilp1Abe de Jong2,3 Douglas V.DeJong4

Ulrich Hege5

1EY and Department of Finance, Rotterdam

School of Management, ErasmusUniversity, PO

Box1738, 3000 DR Rotterdam, Netherlands

2Department of Banking and Finance, Monash

University, 900 Dandenong Road, Caulfield East,

3145 Melbourne, Victoria, Australia

3Department of Finance, Rotterdam School of

Management, ErasmusUniversity, PO Box 1738,

3000 DR Rotterdam, Netherlands

4Tippie College of Business, University of Iowa,

Iowa City, IA, 52242, USA

5Department of Finance, ToulouseSchool of

Economics, 21 Allee de Brienne, 31015, Toulouse

Cedex6, France

Correspondence

DouglasV. DeJong, Accounting, W252 John

PappajohnBus. Bldg., Tippie College of Business,

TheUniversity of Iowa, Iowa City, IA 52242, USA.

Email:douglas-dejong@uiowa.edu

Fundinginformation

FP7Ideas: European Research Council,

Grant/AwardNumber: ERC FP7 GrantNo.

312503-SolSys;Rotterdam School of Man-

agement,Erasmus University; TSE-P; Agence

Nationalede la Recherche, Grant/Award Num-

ber:Grant ANR-17-EURE-0010; CentER Tilburg

University

Abstract

This paper focuses on dominant owners’ use of leverage to finance

their blockholdings and its relationship to dividend policy. We pos-

tulate that blockholder leverage mayimpact payout policy, in partic-

ular when earnings are hit by a negative shock. We use panel data

for Francewhere blockholders have tax incentives to structure their

leverage in pyramidalholding companies and study the effect of the

financial crisis in 2008/2009. We find no difference in payout policy

andfinancial behavior during the 1999 to 2008 period between firms

with levered owners and other firms. However,in the years 2009 to

2011 following the crisis, dividend payouts increase in proportion

to pyramidal debt of dominant owners. We inspect pyramidal enti-

ties individually and find that on average only 60% of dividends are

passed through to the ultimate owners, with the rest predominantly

used to meet debt service obligations of the pyramidal entities.

KEYWORDS

blockholder private leverage, blockholders, concentrated owner-

ship, financial crisis, insider pledging, leverage, margin loans, payout

policy,pyramids

JEL CLASSIFICATION

G32, G34, G35

1INTRODUCTION

Blockholders sometimes use leverage to finance their dominant equity stake in publicly listed companies. This paper

explores the use of private leverage bycontrolling shareholders and the effects of this leverage on company policies,

dividends and investment. Tothe best of our knowledge, this question has not been addressed before.1The extensive

literatureon the role of blockholders implicitly assumes that owners use deep pockets to finance their controlling share

1Dou,Masulis, and Zein (2019) show that insider share pledging may lead to reduced risk-taking.

J Bus Fin Acc. 2020;47:253–292. wileyonlinelibrary.com/journal/jbfa c

2019 John Wiley & Sons Ltd 253

254 ANANTAVRASILPET AL.

blocks; blockholders, however,use debt financing for a number of reasons, such as wealth limitations or tax optimiza-

tion.2The use of blockholder leverage,in hidden ortransparent form, has recently come under scrutiny in a number of

high-profile cases. For example,Casino, one of the largest French food retailers, has been under attack by short sellers

since 2018 over concerns about high leverage in its pyramidalholding companies, forcing it to sell assets and to seek

limited bankruptcy protection in May 2019 (Financial Times, 31 July 2019). Other French groups also made headlines

in recent years over b lockholder leverage,3as did companies in other jurisdictions including the US, even though the

institutional context is often substantially different from that exploredin our paper.4

In our investigation, we focus on the link between blockholders’ debt exposure and the dividend payout policy in

times of crisis, when the need of the dominant owner for cash dividends to service debt may influence corporate deci-

sions. We find that, in difficult times, companies exposedto blockholder leverage are reluctant to cut dividends.

Data availability presents a major challenge given the privacy of information on personal debt, despite a renewed

regulatory interest to understand the consequences of debt financing (Financial Stability Board, 2015). We focus on

France because much of the leverage of large shareholders is in fact structured in holding vehicles. France’sspecific

institutions and personal tax rules convey considerable advantages if leveredowners organize their leverage in these

holding companies. Tax costs of using holding companies are negligible, and tax rules discouragethe use of pyrami-

dal mixedcompanies that combine financial holdings with operating investments. Furthermore, holding companies are

quitetransparent, i.e., we observe ownership structure, financial structure and payout policy of privately-owned as well

as publicly listed companies, including holding companies. Thus, while we cannot observe the use of private leverage

comprehensively,fiscal incentives and the relative transparency of holding vehicles provide a starting point to investi-

gate its consequences. In France, a large majority of listed firms are controlled bydominant owners, as is the case in a

majority of countries (e.g., La Porta, Lopez-de-Silanes, Shleifer,& Vishny, 2000; this observation does not hold for the

US, the UK, and certain other countries).

Webegin by carefully mapping the use of pyramids and pyramidal leverage in France,our proxy for the use of private

leverage by controlling blockholders. A majority of listed companies are characterized byshareholder concentration.

Wefind that a majority of publicly listed companies are organized as pyramids. We show the phenomenon of pyramidal

debt to be widespread: a majority of pyramidal holding companies use some (albeit moderate)leverage, and pyramids

lead to a mean increase of the dominant owner’s leverageexposure by 12.1% or 35.2%, depending on which of our two

measures of pyramidal leverage is used. On the whole, we find that the use of pyramidaldebt is widespread, but that

blockholder leverageon average is moderate.

We then investigate the impact of blockholder leverage on dividend payouts. We do so in two steps. We first

analyze dividend payouts in our panel by focusing on the cross-sectional comparison, controlling for all the usual

variables that are known to influence payout, and then look at the shock of the financial crisis starting in 2008. In our

first investigation,the cross-sectional panel study prior to the financial crisis, we find no difference in payouts between

companies with levered blockholders and those without blockholder leverage.This finding may be due to the fact that

French holding companies overall makea relatively conservative use of leverage, according to our data. From a strict

2For example, according to court filings, Ronald S. Lauder,the owner of a large block in cosmetics and fashion group Estée Lauder Companies, uses debt

apparentlyfor tax motives: “Nearly $400 million of that stock [worth $600 million] is pledged to secure various lines of credit. Many financial planners consider

itimprudent for principal shareholders in a company to borrow against their stock. But it remains a popular way for wealthy taxpayers to get cash out of their

holdingswithout selling and paying taxes” (New York Times, 26 November 2011).

3In August 2019, the controlling blockholder’s shares in publishing and retail conglomerate Lagardère were reportedly worth less than the per-

sonal bank loans secured by them (Financial Times, 27 August 2019). When Carrefour, a large multinational retailer, experienced floundering sales in

2011, observers urged it to cut its dividend, but Nomura analysts cautioned: “Since Carrefour’s core shareholders’ (Blue Capital) investment in Car-

refour is 80 percent debt financed, we question whether they can accept a sharp reduction in dividend” (Reuters, 17 November 2011, http://www.

reuters.com/article/2011/11/17/us-carrefour-analysis-idUSTRE7AG0M220111117). Telecom operator Altice, owner of Cablevision and other US assets,

cameunder duress in 2017 over concerns about its leverage and the use of blockholder leverage by its founder.

4Examplesinclude Steinhoff International of South Africa, engulfed in an accounting scandal in 2017 that led to a 90% share price drop and a fall in the value of

thelargest shareholder’s equity to 25% of the blockholder loan; WorldCom whose CEO Bernie Ebbers had repeatedly used margin loans on his personal equity

before the companycollapsed in 2001; Portuguese bank Espirito Santo that similarly collapsed in 2014; and Chinese manufacturer Geely when it acquired a

largeequity block in Daimler-Benz in early 2018 on margin loans.

ANANTAVRASILPET AL.255

econometric point of view, this finding offers reassurance that we are looking at similar sets of firms in the treatment

and control sample when exploring the crisis impact. An important caveat is that controlling blockholders could also

use other sources of personal income (that we do not observe) to pay for holding company debt or their consumption,

and not just the dividends received from the companies they control; we do not observe, however,equity injections in

holding companies that would indicate such substitution effects.

However, we find strong support for the hypothesis that blockholder leverage affects payout policy in difficult

times. The 2008/2009 financial crisis was an exogenous shock affecting the global economy in almost all developed

economies that led to severe cuts in dividend payouts in listed companies worldwide and also in France (David &

Ginglinger,2016). Crucially, however, the shock should affect companies differently according to the dominant block-

holder’s exposure to private blockholder leverage; we use this heterogeneous intensity of reaction to the treatment

(the financial crisis) for our identification. We find that firms with pyramidal leveragemaintain high dividend payouts

even when cash flows are plummeting and peers are cutting their payouts.

Tolook for additional evidence on the causal link between blockholder leverage and the difference in crisis-induced

payout behavior,we take a closer look at the flow of funds within pyramids for additional evidence that payout deci-

sions are explainedby pyramidal debt. Inspecting pyramids on an entity-by-entity basis, we find that the fraction of div-

idends consumed in each holding company and not passed on to the next entity increases strongly in our measures of

the importance of debt service in that holding company.Dominant owners ultimately receive less than 60% of the cash

that operatingcompanies make available to them, a fraction that decreases strongly in our measures of pyramidal debt.

Finally, we consider the robustness of our finding and extensions. We analyze the consequences of blockholder

leverage for the real policies of the company, but do not find that a dividend increase triggered in times of duress

by a blockholder’s leverage has a measurable effect on corporate investments or risk-taking. We also demonstrate

the robustness when using more conservative measures of pyramidal debt, explore Almeida and Wolfenzon’s(2006)

theory of dividend payouts in pyramids, and take into account double voting rights that in Francemay considerably

enhance the discrepancy between votingand cash flow rights. None of these robustness checks alter our main findings.

Tothe best of our knowledge, our paper is the first to attempt to study the impact of the private leverageof dominant

shareholders via holding company debt or similar vehicles. A similar issue arises when dominant owners use margin

loans where the equity stakeserves as collateral (also known as insider pledging of company stock), as our introductory

examples show; unlikeholding company debt, however, these loans are rarely observable to researchers. Our paper is

related to various strands of the literature that we discuss in more detail in the nextsection. It is obviously related to

the large literature on payout policy,in particular to work on payout policy in companies with dominant blockholders.

This literature is characterized by two conflicting hypotheses, expropriation vs. substitution. Our paper adds to this

literaturewith its analysis of the role of blockholders’ private leverage.Our paper is also related to literature on payout

policy and shareholder-bondholder conflicts, in particular for firms close to financial distress. Our paper contributes

to this literature with the insight that the private leverage of blockholders may exacerbateshareholder-bondholder

conflicts in times of financial distress. Finally, we contribute to the papers on financial structure and payout policy in

pyramidal structures with the insight that blockholder leveragemay be an important determinant of payout decisions

in times of financial distress.

The paper is organized as follows. Section 2 presents the literature and discusses our hypotheses. Section 3

describes the study’s design and data. Section 4 outlines our main results. Section 5 presents further evidence on how

dividends are passed through pyramidal entities. In Section 6, we look at various robustness tests and extensions,and

Section 7 concludes.

2LITERATURE AND HYPOTHESES

Webriefly discuss the various strands of the literature to which our paper is related, on payout policy and blockholders,

on shareholder-creditor conflicts under financial duress, and on pyramids.