The Cost of Multiple Large Shareholders

• DOI: http://doi.org/10.1111/fima.12090
• Published date: 01 May 2016
• Author: David Hillier,Jun Wang,Charlie X Cai
• Date: 01 May 2016

The Cost of Multiple Large Shareholders

Charlie X Cai, David Hillier, and Jun Wang∗

Previous research argues that large noncontrollingshareholders enhance firm value because they

deter expropriation by the controlling shareholder. We propose that the conflicting incentives

faced by large shareholders may induce a nonlinear relationship between the relative size of

large shareholdings and firm value. Consistent with this prediction, we present evidence that

there are costs to having a second (and third) largest shareholder, especially when the largest

shareholdings are similar in size. Our results are robust to various relative size proxies, firm

performance measures, model specifications, and potential endogeneity issues.

Large noncontrolling shareholders are important guardians of minority shareholder interests

and can enhance firm value through their monitoring activity (Pagano and R¨

oell, 1998; Bennedsen

and Wolfenzon, 2000; Maury and Pajuste, 2005; Laeven and Levine, 2008; Attig, El Ghoul, and

Guedhami, 2009a). We argue that these shareholders may, instead, choose to collude with the

controlling shareholder if it is in their mutual interests. Further, the choice of whether to monitor

or collude will depend upon the ratio of the controlling shareholder investment to that of other

large noncontrolling shareholders. We refer to this as the Ownership Wedge (OW).1

Large noncontrolling shareholders havethe potential to play two roles. They have the incentives

and voting power to constrain the objectives of the controlling shareholder (Gomes, and Navaes,

2006), but they may also join the controlling shareholder in expropriating wealth from smaller

shareholders.2

We propose a simple model that captures the contrasting incentives of the second largest

shareholder. When the controlling shareholder’s investmentis much larger than that of the second

largest shareholder (that is, when OW is large), any increase in the second largest shareholder’s

investment will lead to an increase in firm value. However, as the relative shareholdings converge

in size (when OW approaches one), firm value will fall as a result of this collusion. This is because

the private benefits from monitoring and collusion vary with the ownership wedge, OW.

Wecontribute to the literature by testing the proposition that fir m valueis affected by a trade-off

between the monitoring and collusion incentives of noncontrolling large shareholders. Using a

number of different relative shareholder size metrics, we find that the relationship between the

We would like to thank the Centre for Advanced Studies in Finance, University of Leeds, for its financial support. We

are grateful to an anonymous referee, Robert Faff, David Reeb, Krishna Paudyal, Marco Bigelli, Julio Pindado, Andy

Marshall, Patrick McColgan, Paul McGuinness, Raghavendra Rau (Editor), and participants in the FMA Europe2014

in Maastricht for their insightful comments. All errors areour own.

∗Charlie X Cai is a Professorof Finance at Leeds University Business School at the University of Leeds in Leeds. David

Hillier is Professor and Executive Dean at StrathclydeBusiness School at the University of Strathclyde in Glasgow,UK.

Jun Wangis a Lecturer in Accounting and Finance at Dundee Business School at the University of Abertay Dundee in

Dundee, UK.

1Other terms have been used to represent this concept. Maury and Pajuste (2005) use “control contestability” and

“distribution of voting rights among large shareholders” to represent the large shareholder ownershipdifferential. Laeven

and Levine (2008) use “distribution of cash-flow rights among large shareholders.”

2Gomes and Novaes(2006) and Bennedsen and Wolfenzon (2000) both argue that multiple large shareholders reduce the

level of minority expropriation,while Bennedsen and Wolfenzon (2000) focus on the formation process of the controlling

group and Gomes and Novaes (2006) concentrate on the ex post bargaining games among a controlling coalition.

Financial Management •Summer 2016 •pages 401 – 430

402 Financial Management rSummer 2016

Ownership Wedge (OW) and firm value (both Tobin’s Qand Market-to-Book Value) is concave.

In particular, firm value is at its greatest when the second largest shareholder’s holding is about

40% of the controlling shareholder’s holdings.

Using a comprehensive sample of Chinese firms from 2003 to 2011, we present clear evidence

of a nonlinear relationship between the Ownership Wedge and firm value. The turning points in

this relationship are directly related to board quorums and majority voting thresholds, suggesting

that large shareholders take advantage of corporate governance regulations when exercising their

power to influence management behavior. Our results hold true irrespective of the way in which

large shareholders and shareholder identities are defined, and are robust to endogeneity, model

specification, variable proxies, and regulatory changes.

We focus specifically on Chinese listed companies for two reasons. First,multiple large share-

holders are a common phenomenon in Chinese markets. More than 49% (30%) of listed companies

have at least two large shareholders when using a 5% (10%) ownership threshold. In addition,

minority shareholder expropriation is pervasive, and occurs through mechanisms such as related

party transactions (Cheung et al., 2009), inter-corporate loans (Jiang, Lee, and Yu, 2010), ex-

traordinary dividends (Lee and Xiao, 2004; Chen, Jian, and Xu, 2009a), and related party loan

guarantees (Berkman, Cole, and Fu, 2009), all frequently used by controlling owners.

By focusing on Chinese listed companies, we expand the research on the association between

large shareholders and firm performance in a non-Western context. Previous literature investigates

this issue in Europe (Laeven and Levine, 2008; Jara-Bertin, Lopez-Iturriage, and Lopez-de-

Foronda, 2008; Attig, Guedhami, and Mishra, 2008), East Asia (Attig et al., 2008, 2009a), Finland

(Maury and Pajuste, 2005), Italy (Gianfrate, 2007), Columbia (Guti´

errez and Pombo, 2009), Spain

(Gutierrez and Tribo, 2003), Switzerland (Isakovand Weisskopf, 2009), and France (Belot, 2008).

To the best of our knowledge, no attention has been paid to Chinese listed companies, which

operate in an environment where tunneling and other forms of expropriation are common.

The rest of the paper is structured as follows. In Section I, we present a brief literature

review, which leads to the development of our core propositions. Section II describes the data

and methodology. Section III presents our core empirical results and robustness checks. Finally,

Section IV provides our conclusions.

I. Literature Review and Hypotheses

In recent years, the literature regarding multiple large shareholders has grown substantially. By

their very nature, multiple large shareholders have an influence on all dimensions of corporate

strategy,which is reflected in the breadth of topics that have been investigated in the literature. For

example, Bolton and Thadden (1998) examine their influence on market liquidity, while Maury

and Pajuste (2005) analyzeprof it diversion whena f irm has several large shareholders. Dhillon and

Rossetto (2009) explore how large shareholders affect firm-level investment policy and Edmans

and Manso (2011) investigate their role in enforcing managerial discipline. Other papers have

considered control contestability (Bloch and Hege, 2003), business decision approvals (Gomes

and Navaes, 2006), monitoring of the controlling shareholder (Winton, 1993; Pagano and R¨

oell,

1998; Bolton and Thadden, 1998), and private benefits of control (Bennedsen and Wolfenzon,

2000; Zwiebel, 1995; Gomes and Navaes, 2006; Pagano and R¨

oell, 1998). Finally, the literature

has also examined the indirect effect of multiple large shareholders, including their influence on

operating performance (Lehmann and Weigand, 2000; Gutierrez and Tribo, 2003; Guti´

errez and

Pombo, 2009; Isakov and Weisskopf, 2009), expropriation (Gianfrate, 2007), equity costs (Attig