Estimating the Effects of Large Shareholders Using a Geographic Instrument
Executive Summary — Are large shareholders good monitors of management? A public firm's shareholders have extensive legal control rights in the corporation, but in practice much of this control is delegated to managers. In companies with small, dispersed shareholders, owners may find it costly to coordinate and exercise monitoring and control, leaving management with considerable discretion. Large shareholders, however—by concentrating a block of shares in the hands of a single decision-maker—may play a beneficial role in facilitating effective owner control. Yet large shareholders are not without their costs. HBS professor Bo Becker and coauthors develop and test a framework to quantify the impact of large owners (individual non-managerial blockholders, not mutual funds or other institutions) on several key aspects of firm behavior. They show that such shareholders play an important role for corporate governance in sizable U.S. public firms, and can affect several firm policies. Key concepts include:
- Non-managerial individual shareholders hold blocks in firms that are headquartered close to where they reside.
- Large shareholders systematically target firms based on where the benefits from additional monitoring are expected to be more significant, such as smaller and relatively poorly performing firms.
- The presence of a large shareholder significantly reduces a firm's investments, reduces corporate cash holdings, increases payouts to shareholders, reduces total top executive pay, and increases firm performance.
- Firms with blockholders also have significantly more outside directors on their boards.
- Block presence also comes with costs, such as less liquid publicly traded shares. This may reflect a smaller float as well as the presence of privately informed traders (the blockholders).
Large shareholders may play an important role for firm performance and policies, but identifying this empirically presents a challenge due to the endogeneity of ownership structures. We develop and test an empirical framework which allows us to separate selection from treatment effects of large shareholders. Individual blockholders tend to hold blocks in public firms located close to where they reside. Using this empirical observation, we develop an instrument - the density of wealthy individuals near a firm's headquarters - for the presence of a large, non-managerial individual shareholder in a firm. These shareholders have a large impact on firms, controlling for selection effects. 60 pages.