Summaries of recent and interesting research papers

Shareholder structure, performance and enterprise value

The main findings on shareholder structure and its links with price performance and enterprise value go back to the work of E. Fama and M. Jensen (1983) and of H. Demsetz (1983) on the other. These findings have recently been critically re-examined.

E. Fama, M. Jensen, and H. Demsetz suggested that the combination of ownership and control inevitably hinders efficiency and profitability. Under this assumption, the presumed underperformance of family-held companies would be due to:

• the rejection of potentially profitable projects, the financing of which could threaten family control;
• the lack of competition in selecting the most qualified person to run the company.

Given the large number of family-held companies (44% of listed European companies and more than one third of the S&P 500), the issue of the relationship between shareholder structure, performance and enterprise value is worth reconsidering.

In a recent study, R. Anderson and R. Reeb (1) take the opposing view of E. Fama, M. Jensen and H. Demsetz. They show that the performance of family-held companies is, on average, better than other companies', on the basis of a sample of S&P 500 companies from 1992 to 1999. The gap is especially wide when the CEO is the company founder.
Looking more closely, the authors found that the relationship between listed family-held companies and their performance measured by ROE and the Tobin q ratio (market value/book value) is not linear. Outperformance is very strong up to a 32% family stake in the business, then declines beyond this threshold, while remaining in positive territory.
Beyond 32% ownership, it can be assumed that the family intends to retain its de facto control, which can make it less inclined to maximise value.
Below 32%, it does not have control or, at best, loose control, and its best protection of both its financial interests and its position, is to achieve the best possible performances.
The traditional assumption that family-held companies are inefficient and neglect the interests of minority shareholders is thus disproved. This will come as no surprise when you consider that the best-performing family-controlled company in the last 20 years has been L'Oréal, which is still controlled by its founding family, with an average return of 19% per year since 1984, a Tobin q of 5.4 in 2004 and 19% ROE in 2003.

M. Lemmon and K. Lins (2) studied the impact of shareholder structure on firm value during the Asian crisis. The idea is that conflicts of interest, and, more generally, all problems linked to agency relations between ownership and management (insiders) and outside investors (outsiders), are an issue in a crisis context and in economies where wedding cake-like control structures are common.

Based on a survey of 800 companies, the two authors found that companies with wedding-cake-like shareholder structures structurally underperform the others. This underperformance is especially significant in companies whose managers have greater control. The authors conclude by stressing the importance of shareholder structure in determining how inclined and how able insiders are to "expropriate" minority shareholders.

Based on this conclusion, we are curious about the relationship between treatment of minority shareholders and the firm's value. And this is precisely the subject of research by R. La Porta, F. Lopez-de-Silanes, A. Shleifer, and R. Vishny (3). They analysed different possible legal environments and reviewed the effect of the degree of protection of minority shareholders on firm value.
To do so, they put together a sample of 539 companies from 27 of the richest countries. The decisive criteria in choosing the companies was the existence of a majority or controlling shareholder, since the purpose of the research is to determine what type of legal system is most able to limit the inclination of a majority shareholder to expropriate minority shareholders.
To test the hypothesis that the more the legal environment is protective, the higher the firm value, the authors used different variables, such as the Tobin q, to estimate value.
In accordance with their hypothesis, and unsurprisingly, their empirical study found that the more that minority shareholders are protected by law, the greater the value of the company. Just as it might be expected.

H. Cronqvist and M. Nilsson (4) sought to measure the loss in value at a listed company that is controlled by shareholders holding a minority of the shares but a majority of voting rights. (They would be able to do so through multiple voting rights, of which there are many examples in Sweden.) Under a classic schema, "A" shares have 10 voting rights, while "B" shares have just one voting right. But we can find even better than that, at Ericsson, for example, where "A" shares have 1000 voting rights and "B" shares, a single voting right. This is how the Wallenberg family, which owns just 5.3% of the shares, controls 38.3% of the voting rights, and how Svenska Handelsbanken controls 34.7% of the voting rights with just 3.14% of the shares.
As might be expected, the authors found that this type of structure is more likely to be used by families to maintain control and that the resulting discount ranges from 6 to 25 %. Similarly, the return on assets is below that of similar firms.
Can we therefore say that these companies necessarily destroy value for minority shareholders? No, not necessarily, as the shareholders have bought their shares at a discount, given that such voting rights structures are naturally set up prior to floatation. However, when return stubbornly remains below that of peers it is not a sign of maximum efficiency.
With 20/20 hindsight, we can see that if Ericsson's share price did not vary the week after the announcement of a cut in "A" voting rights from 1,000 to 10, it is simply because the two main shareholders will still have 40% of voting rights, while holding just 8.4% of the shares. "Plus ça change…", as they say.

(1) R.C. Anderson and D.M. Reeb, "Founding-Family Ownership and Firm Performance: Evidence from the S&P 500", The Journal of Finance, 3 June 2003.
(2) "Ownership Structure, Corporate Governance and Firm Value: Evidence from the East Asian Financial Crisis", The Journal of Finance, August 2003.
(3) "Investor Protection and Corporate Valuation", The Journal of Finance, 3, June 2002.
(4) "Agency costs of controlling minority shareholders", Journal of Financial and Quantitative Analysis, December 2003.