The Role of Multiple Large Shareholders in the Choice of Debt Source

• Date: 01 March 2017
• Author: Wael Rouatbi,Walid Saffar,Sabri Boubaker
• DOI: http://doi.org/10.1111/fima.12148
• Published date: 01 March 2017

The Role of Multiple Large Shareholders

in the Choice of Debt Source

Sabri Boubaker, Wael Rouatbi, and Walid Saffar∗

This paper examines the effect of multiple large shareholders (MLS) on debt choice. Using a

sample of 654 French-listed firms over the period 1998-2013, we find that reliance on bank

debt increases with the presence and voting power of MLS. This result is robust to endogeneity

concerns and to several sensitivity tests. Moreover,we find that the effect of MLS on debt choice is

more pronouncedwhen agency problems between controlling and minority shareholdersare more

severe. Taken together, our results suggest that MLS reduce the controlling owner’s incentive to

avoid bank monitoring, leading to greater reliance on bank debt.

Although the firm’s choice of debt source is a central theme in corporate finance, researchers

have only recently begun to shed light on the relation between ownership structure and the

debt financing choice. For instance, Denis and Mihov (2003) provide evidence that managerial

ownership affects debt choice. Lin, Ma, Malatesta, and Xuan (2013) find that the control-

ownership divergence of the controlling owner is associated with lower reliance on bank debt

financing. However, the large body of research on capital structure has thus far been silent on

the role that multiple large shareholders (MLS), other than the controlling owner, may play in

determining debt source. In this paper, we investigate whether the presence of MLS influences

the firm’s choice of debt instrument.

The governance role of MLS has been increasingly recognized in the literature. Prior studies

indicate that MLS have incentives (large cash flow rights) and power (large voting rights) to par-

ticipate in the firm’s internal decision process, which affects firm valuation and decision making

(Faccio, Lang, and Young,2001; Maur y and Pajuste,2005; Attig, El Ghoul, and Guedhami, 2009;

Boubaker, Cellier,and Rouatbi, 2014). However, the impact of MLS on financing decisions, such

as the choice of debt source, remains underexplored. Our objective is to narrow this gap by ad-

dressing the following questions. Does the presence of MLS affect a firm’sreliance on bank debt

financing? And, if so, does the severity of agency problems between controlling and minority

shareholders affect the role of MLS in determining debt choice?

The corporate governance literature offers two views regarding how MLS could affect the

choice of debt source. The first view is based on the idea that MLS play a monitoring role in

Wethank Sadok El Ghoul, Dimitrios Gounopoulos, Duˇ

san Isakov,Ranko Jelic, Meziane Lasfer, David Michayluk, Jeffrey

Ng, Pascal Nguyen, Raghavendra Rau (Editor), Samir Saadi, and an anonymous refereefor their helpful comments and

suggestions on earlier versions of the paper. We are also grateful for the comments made by seminar participants at

the Paris Financial Management Conference, Paris, France (2014), the Institut de Recherche en Gestion, Universit´

e

Paris-Est,France (2015), Accounting and Finance Research Seminars,the University of Sussex, United Kingdom (2015),

the WorldFinance Conference, Buenos Aires, Argentina (2015), andthe 6th International Research Meeting in Business

and Management, Nice, France(2015). All errors are our own responsibility.

∗Sabri Boubaker is an Associate Professor of Finance in the ChampagneSchool of Management (Groupe ESC Troyes)

and a Research Fellow at Universit´

e Paris-Est, IRG (EA 2354), UPEC, F-94000, Cr´

eteil, France. Wael Rouatbi is an

Assistant Professor of Finance in Montpellier Business School - Montpellier Research in Management in Montpellier,

France. Walid Saffar is an Associate Professorof Finance in the School of Accounting and Finance at The Hong Kong

PolytechnicUniversity, Hong Kong.

Financial Management •Spring 2017 •pages 241 – 274

242 Financial Management rSpring 2017

alleviating the agency conflicts between the largest controlling owner and minority shareholders

(Pagano and R¨

oell, 1998; Bennedsen and Wolfenzon, 2000). Prior research suggests that self-

interested controlling owners tend to behave opportunistically by diverting corporate resources

(Shleifer and Vishny, 1997; Bebchuk, Kraakman, and Triantis, 2000; Claessens, Djankov, Fan,

and Lang, 2002). Therefore, they may avoidbank debt since banks have better monitoring ability

than other lenders. For instance, banks can access inside information that is not availableto other

types of borrowers and have superior ability to punish the borrowing firm through liquidation or

the renegotiation of loan contract terms (Stiglitz and Weiss,1983; Fama, 1985; Rajan, 1992; Park,

2000). From this perspective, controlling owners prefer to reduce their firm’s reliance on bank

debt financing as a way of protecting their private benefits of control. Since MLS have strong

incentives and powerto monitor the controlling owner and to inhibit her diversion activities, their

presence reduces her incentive to avoid bank monitoring resulting in greater firm reliance on

bank debt.

An alternative view draws on the possibility that MLS choose to collude with the controlling

ownerto extract private benefits at the expense of minority shareholders (Zwiebel, 1995; Kahn and

Winton, 1998). In this vein, Faccioet al. (2001) f ind that the presence of MLS decreases dividend

rates in East Asia. The authors interpret this result as evidence that large owners form controlling

coalitions to expropriate minority shareholders. Maury and Pajuste (2005) provide evidence that

coalitions between large shareholders can facilitate profit diversion resulting in lower firm value.

Attig, Guedhami, and Mishra (2008) find that when the largest and the second largest shareholders

are families, the market perceives a greater expropriation risk through coalition resulting in a

higher cost of equity capital. Cai, Hillier, and Wang (2016) show that MLS are more inclined to

divert corporate resources when their shareholdings are similar in size to that of the controlling

owner. Forming a controlling coalition to share private benefits creates incentives for MLS to

reduce the firm’s reliance on bank debt as they anticipate heightened monitoring by banks. Thus,

it is likely that the presence of MLS is associated with a lower proportion of bank debt in total

debt.

In this paper, the relationship between the presence of MLS and firm debt choice is treated as

an empirical issue. Weconduct our analysis on a sample of 6,238 f irm-year observations covering

654 French-listed firms from 1998 to 2013. Using a simultaneous equations framework wherein

the controlling owner’s entrenchment and the effectof MLS on debt choice are jointly determined,

we confirm that the presence of MLS affects the firm’s reliance on bank debt. Specifically, we

find compelling evidence that firms with MLS tend to rely more heavily on bank debt financing.

This finding supports the view that MLS reduce the preference of the controlling owner to avoid

bank debt to protect her private benefits of control. Wealso provide evidence that the voting power

of MLS relative to the controlling owner significantly affects the proportion of bank financing in

a firm’s total debt.

These findings are robust to endogeneity concerns and to several sensitivity tests. We employ

three approaches to control for potential endogeneity problems. First, we reestimate our main

regressions using a propensity score matched sample that includes firms with MLS and f irms

without MLS. In addition, we estimate a change regression by considering a model that regresses

the change in the ratio of bank debt to total debt on the change in the voting power of MLS.

Moreover, we use an instrumental variable approach. Our results also stand up to a battery of

robustness checks including the use of alternative MLS and debt choice variables and alternative

sample compositions. In addition to the debt source, we also explore the effect of MLS on

the firms’ debt-to-equity choice. We find that both the presence and voting power of MLS

are associated with higher debt financing, which is consistent with the literature regarding the

monitoring role of MLS.

Boubaker, Rouatbi, & Saffar rMultiple Large Shareholders and Debt Source 243

In an additional analysis, we find that the identity of the second largest shareholder

matters in explaining the firm’s reliance on bank debt financing. In particular, we con-

firm a positive and significant link between the existence of a family or a widely held

financial institution as the second largest shareholder and the ratio of bank debt to to-

tal debt suggesting the superior monitoring abilities of these two types of large share-

holders. However, the presence of the State or a widely held corporation as a second

largest shareholder does not seem to have an impact on the firm’s reliance on bank debt

financing.

Furthermore, we examine whether the severity of agency problems between controlling and

minority shareholders influences the effect of the presence of MLS on debt choice. In particular,

our findings reveal that the effect of MLS on debt choice is more pronounced in firms with

higher levels of free cash flow, in firms facing lower product market competition, and in pyramid-

affiliated firms. These f indings support the view that MLS play a stronger governance role in

firms with higher expropriation likelihood.

This study contributes to the literature in several important aspects. First, it adds to research

on capital structure choice by providing the first rigorous evidence concerning the effect of

MLS on firms’ reliance on bank debt f inancing. Thus, this study complements prior research

by Denis and Mihov (2003) and Lin et al. (2013), who find that ownership structure plays an

important role in determining debt choice. In addition, this paper extends previous work on

the governance role of MLS (Maury and Pajuste, 2005; Attig et al., 2008, 2009) by show-

ing that MLS play an efficient monitoring role that has a significant impact on fir m’s debt

choice. Moreover, the present work sheds light on a channel through which large shareholders

influence debt choice adding a new dimension to our understanding of the relation between

ownership structure and firm financial decisions. Fur thermore, the present paper augments em-

pirical research regarding the determinants of the choice of debt source by focusing on the

French context. French firms are typically closely held and exhibit substantial separation of

ownership and control, which induces severe agency conflicts between controlling owners and

minority investors (Faccio and Lang, 2002). Additionally, French firms are often controlled by

more than one large shareholder (Faccio and Lang, 2002; Laeven and Levine, 2008). Thus,

France provides an excellent laboratory for understanding the role of MLS in the choice of debt

source.

In addition, the French market is appropriate for this analysis for at least two reasons.

First, the French capital market is bank-oriented (Guenther and Young, 2000) implying that

the debt of French firms is, to a large extent, provided by banks. In this vein, Antonczyk,

Breuer, and Salzmann (2014) report that bank loans dominate the lending market in France

when compared to other types of debt (e.g., public debt and nonbank private debt). Moreover,

the characteristics of the French capital market enhance the generalizability of our results to

many bank-oriented countries that have similar corporate governance structures. Nevertheless,

focusing on the French context is an acknowledged limitation of this study since our find-

ings could be dependent upon the French-specific regulatory, cultural, institutional, and market

characteristics.

The rest of the paper is organized as follows. Section I develops the hypotheses related to the

influence of MLS on debt choice. Section II details the sample selection criteria and the data

sources, presents the definitions of the variables used in the empirical analysis, and provides

summary statistics. Section III covers the empirical evidence and robustness checks. Section IV

presents evidence regarding the impact of the severity of agency problems between controlling

and minority shareholders on the role of MLS in debt choice, while Section V provides our

conclusions.