Ownership Concentration and Institutional Quality: Do They Affect Corporate Bankruptcy Risk?

• Published date: 01 August 2019
• Date: 01 August 2019
• DOI: http://doi.org/10.1111/ajfs.12271
• Author: Jounghyeon Kim

Ownership Concentration and Institutional

Quality: Do They Affect Corporate

Bankruptcy Risk?*

Jounghyeon Kim**

Department of Economics, Chosun University, Republic of Korea

Received 14 August 2018; Accepted 7 April 2019

Abstract

Using the Worldwide Governance Indicators and enterprise survey data from the World Bank

in 41 countries, this paper explores the relationship between ownership concentration and

institutional quality and their association with corporate bankruptcy risk. The analytical

results indicate an inverse relationship, suggesting that concentrated ownership is higher in

countries with lower governance quality. This paper also finds that ownership concentration

and institutional quality reduce bankruptcy risk and that in countries with stronger institu-

tional quality, concentrated ownership has a weaker effect on bankruptcy risk. This implies

that ownership concentration as a corporate governance mechanism can play a substituting

role for weak governance quality and that such a role is more significant in countries with

weaker institutional quality.

Keywords Corporate governance; Ownership concentration; Institutional quality; Bankruptcy

risk

JEL Classification: G32, G33, G34, P48

1. Introduction

Corporate governance is one of the most important mechanisms that influence cor-

porate performance. Strong corporate governance, such as a solid legal system for

protecting minority investors, helps improve a firm’s valuation and profits, while

governance quality is generally higher in countries with better legal protection for

investors (Johnson et al., 2000; La Porta et al., 2002; Mitton, 2002; Gompers et al.,

2003; Klapper and Love, 2004).

1

In contrast, major shareholders can easily extract

*The author would like to thank two anonymous referees’ helpful comments.

**Corresponding author: Department of Economics, Chosun University, 309 Pilmun-daero,

Dong-gu, Gwangju, Jeonnam 61452, Republic of Korea. Tel: +82-62-230-6823, Fax: +82-62-

226-9664, email: jhyeon@chosun.ac.kr.

1

Cheung et al. (2010) find thatgood corporate governance improves stock returnin Hong Kong.

Asia-Pacific Journal of Financial Studies (2019) 48, 531–560 doi:10.1111/ajfs.12271

©2019 Korean Securities Association 531

benefits from a company for the sake of their own interest under weak investor

protection. Accordingly, weak corporate governance gives rise to poor valuation

and profitability (Joh, 2003; Claessens, 2006). These findings suggest that strong

corporate governance plays a crucial role in protecting minority shareholders from

expropriation, especially in determining corporate ownership structures, along w ith

valuation and efficient allocation of resources (La Porta et al., 2000).

The association between ownership concentration and corporate performance

has also been extensively studied in the corporate governance literature. For exam-

ple, higher ownership shares by large shareholders can enhance firm valuation in

countries with weak investor protection (Holderness and Sheehan, 1988; Zeckhauser

and Pound, 1990; Claessens et al., 1999; La Porta et al., 2002). In such countries,

higher ownership concentration can protect minority shareholders from the expro-

priation of entrepreneurs and improve corporate performance, which is similar to

corporate governance (Jensen, 1976; La Porta et al., 2002).

2

Needless to say, strong corporate governance is indispensable to good corporate

performance. In turn, sufficient capital flows, such as high retained earnings and

net income can help lower the likelihood of corporate bankruptcy (Shumway, 2001;

Alexeev and Kim, 2012). Since ownership concentration is inversely related to gov-

ernance quality, especially in countries with weak institutional quality (La Porta

et al., 1998, 1999; Claessens et al., 2000; Shleifer and Wolfenzon, 2002), concen-

trated ownership can play a substituting role as a corporate governance mechanism

and improve corporate performance (Heugens et al., 2009; Nguyen et al., 2015);

consequently, firms are less likely to go into financial distress. However, in the pres-

ence of strong governance quality, the effect of ownership concentration as a gover-

nance mechanism on corporate performance becomes weaker (Heugens et al., 2009;

Nguyen et al., 2015).

It can be inferred from these points that in countries with weak corporate gov-

ernance, large shareholders presumably expropriate wealth from minority share-

holders for their private benefit and, subsequently, firms are likely to suffer from

lower valuation and experience financial distress (La Porta et al., 2000; Lee and

Yeh, 2004). In other words, firms with lower governance quality are more suscepti-

ble to financial distress, which may lead to bankruptcy (Chan et al., 2016). On the

other hand, higher ownership concentration can play an effective monitoring role

in reducing the likelihood of corporate bankruptcy (Fich and Slezak, 2008) and is

expected to have a weaker effect on the risk and/or likelihood of bankruptcy in

countries with better institutional quality.

As described above, the previous studies present useful information on not only

the relationship between ownership structure and institutions but also their

2

Friedman et al. (2003) show that the effect of debt on an entrepreneur’s behavior depends

on the rate of return on the investment and that when there is a moderate negative shock on

the investment, an entrepreneur supports the firm by borrowing, that is, issuing debt and

expropriating less.

J. Kim

532 ©2019 Korean Securities Association