How does a firm’s ownership structure influence its behavior? Given its potential to impact firms’ ability to incorporate externalities in their decisions and to improve society’s allocation of risk, understanding this relationship is closely linked to core goals of the TSE Sustainable Finance Center. Existing research on ownership structure and risk-taking by firms has largely focused on the importance of the largest blockholder. In a new working paper, TSE’s Silvia Rossetto builds on her theoretical work with an empirical analysis of the role of mid-sized blockholders.
What is the typical ownership structure?
Firms across countries and sectors display a range of complex ownership structures but the most common structure has multiple large investors. In the United States, 69% of publicly listed firms have more than one blockholder (defined as a shareholder with a stake of 5% or more), 28% of firms have one blockholder, and only 3% of firms have no blockholders. Similarly, more than 34% of European firms have at least two large investors; and 12% have more than two large investors.
What do previous studies reveal about the link between ownership concentration and firm risk?
The starting point for many studies on ownership structure is the belief that a large blockholder helps overcome the free-rider problem in monitoring a firm manager. As a larger blockholder tends to be exposed to more firm risk, one would expect firms dominated by a large blockholder to take less risk. In a 2008 cross-country empirical study, a weak negative relationship was documented between the largest blockholder’s stake and firm risk. A similar analysis in 2011 using European data found that firm risk is positively related to the largest blockholder’s stake and their degree of diversification.
The presence of a large shareholder triggers a conflict of interest between shareholders. A large blockholder might prefer low-risk-return projects, whereas small shareholders might prefer high-risk-return projects. Mid-sized blockholders may create value by mitigating this conflict of interest. In a previous theoretical study (‘Ownership Structure, Voting, and Risk’ in The Review of Financial Studies, 2015), my co-author and I show that when firms make investment decisions through shareholder voting and some small shareholders abstain from voting, mid-sized blockholders may emerge and become pivotal voters, and the largest shareholder may no longer determine risk choices. In such a setting, the larger the number of blockholders, the more the firm risk.
How does your latest study investigate the role of mid-sized blockholders?
Existing empirical studies have overlooked the role of mid-sized blockholders in firms’ policies and risk profiles. In my current working paper, we aim to correct this by examining whether these blockholders play a role in determining firm risk. Building on the findings of my 2015 study, the new paper empirically tests whether the power of the largest blockholder is the only dominant driver of firm risk choices. To do so, we use data on ownership structure from US listed firms from 2009 to 2017. For firm risk, we mainly consider the volatility of operating performance computed over four-year overlapping periods. Alternatively, we use annual share price volatility and idiosyncratic risk.
What are your key findings?
We first try to replicate existing research by determining whether the exposure of the largest blockholder can predict the next-period firm risk. As previously documented, we find a weak negative relationship between this exposure and firm risk. However, when we analyze ownership structure beyond the simple largest blockholder size, we find that firms with more blockholders are riskier.
We succeed in confirming my 2015 study’s theoretical prediction of a positive relationship between the number of blockholders and firm risk. Our empirical analysis shows that when the number of blockholders increases from one to two, firm risk increases by 22%.
Overall, we conclude that ownership structure matters for risk-taking and that this relationship is more complex than previously thought. Rather than considering only firms with and without blockholders, or focusing purely on the largest blockholder, future research must take into account the active role of mid-sized blockholders in determining firm policy.
Can portfolio theory explain the relationship between ownership structure and risk?
Portfolio theory predicts that if shareholders were perfectly diversified, specific risk would not matter, and there would be no relationship between risk and ownership structure. However, when shareholders are poorly diversified, a shareholder’s stake will affect the firm’s willingness to take risk. On average, the larger the number of blockholders, the smaller the stake of the pivotal mid-sized blockholder. This implies that shareholders with a smaller stake are less exposed to firm-specific risk and so more willing to support decisions that increase firm risk. We test whether the number of blockholders is related to specific risk. Our results confirm the idea that blockholders who are in control, and hold a less diversified portfolio, affect firm policies by voting in favor of low specific-risk proposals.
Is it possible that higher firm risk leads to disperse ownership?
Our results are robust to controlling for blockholder type and firm characteristics. We carry out various robustness checks to tackle endogeneity issues. In particular, we carry out three direct tests to exclude the following hypotheses: risk determines the number of blockholders, risk changes in anticipation of a change in the number of blockholders, and the number of blockholders changes in anticipation of a change in risk.
FURTHER READING Silvia’s publications including ‘Ownership concentration and firm risk: The moderating role of mid-sized blockholders’, coauthored by Nassima Selmane (University of Groningen) and Raffaele Staglianò (Università degli Studi di Messina), are available on the TSE website.
Interview published in TSE Reflect, December 2022
Photos: © Adobe Stock, Unsplash
- Silvia Rossetto
- Nassima Selmane
- Raffaele Staglianò