Agency costs and ownership structure - Essay Example

Running head: Agency Costs and Ownership Structure Agency Costs and Ownership Structure: A Review of the Performance of Family-owned, Public, and Private Firms and the Effect of Ownership Changes Abstract A firm is a team effort involving several players - the owners, managers, shareholders, and lenders - that should work together to maximise the value of the firm in terms of profitability, sustainability, and performance. Recent experience, however, in the wake of business bankruptcies and scandals show that this team effort is not achieved in several cases. By analysing the ownership structure of the firm, agency theory provides an explanation for firm failure and performance. In theory, the alignment of interests between the principals (owners) and agents (managers) entails agency costs that affect firm value, so firm value can be maximised to the extent that principals and agents minimise agency costs. This paper reviews the available literature on the effects of family ownership, public ownership, and the dispersal of ownership on firm performance and value and provides a summary of the status of our knowledge of these relationships. Executive Summary Agency theory explores the effects of ownership structure on the performance of the firm. The theory states that the value of a firm will depend on the extent to which the interests of principals (owners) and agents (managers) are aligned. However, the interests of the principals are not the same as the interests of the agents, so aligning the two sets of interests will incur so-called agency costs. In this paper, we review the available literature on the application of agency theory in two types of ownership structures. First, we looked at firms that are majority owned, managed, or controlled by a single family and explored whether the aligned interests resulted in lower agency costs and better firm performance. In general, research findings supported the predictions of agency theory: firms where the founder-CEO, or a CEO-heir after the second generation, plays an active management role performed better than firms that are not dominated by a single family. Research also showed that in some cases where a single family dominated the firm, a second type of agency cost that researchers term as "expropriation" have a negative effect on firm value as the dominant owners "expropriate" perquisites and other benefits to the detriment of minority owners. Second, we compared the performance of public and private firms. Research studies that included firms from a wide range of industries supported the agency theory, but the probability that results were influenced by factors that are endogenous to specific industries affect their external validity, or general applicability, to other industries. By looking at the results of a focused study using sample firms from one industry, we were able to establish the validity of agency theory in explaining firm performance. We also looked at the literature on the effects of a diversified ownership base on firm performance as reflected by stock price, with mixed results due to the effects of increased liquidity, rather than minimisation of agency costs, on improved firm performance. Introduction One of the most discussed topics in finance and economics is the ideal ownership structure that will maximise the value of the firm. This issue touches the core of why firms exist in the first place -to maximise profit for its owners - and explains partially how and why previously successful firms fail. Economists used to assume that everyone - owners, managers, employees, and lenders - act together for the good of the firm. After all, each one is bound by formal and informal contracts to ensure that firm value is maximised (Brealey and Myers, 1996, p. 991). This however seldom happens as there are conflicts of interest that affect firm performance, a phenomenon that academics have attempted to investigate over the last seventy years under the conceptual lens of ownership structure. How and why do some firms that succeeded while under management by its founder-owner eventually fail Why are some firms profitable and successful, and are said to be well managed, while some firms lose money and fail, and therefore are said to be poorly managed These questions investigate why and how failure or success happens in firms and whether being managed by owners or by hired professional managers makes any difference. The agency theory relates firm performance to the analysis of its ownership structure. Agency theory essentially states that the interests of the owners (principals) of the firm are not the same as the interests of its managers (agents) who were hired by the principals to maximise the value of the firm, so if the owners want the managers to have the same interests as they (owners) do, then owners have to pay the price in the form of "agency costs" to make managers think like owners. The agency cost is therefore the amount by which the firm's value is diminished below its maximum because the firm is not run and operated by its owners but by hired managers. This paper looks at the body of significant research related to two issues on the ownership structure of firms. Following a brief review of agency theory, we look at the performance of public, family-owned, and managed firms and compare it with non-family owned firms. Family ownership means that a single family owns the majority of the shares of a firm and therefore exercises greater control over the management. Second, we look at the literature comparing the performance of privately owned and publicly owned firms, and investigate how widespread public ownership affects the maximisation of firm value. Agency Theory Berle and Means (1932) were the first to point out that the interests of the owner and the manager in a firm may diverge because of the separation of ownership and control and the disappearance of the system of checks and balance that operate as a means to exercise power. They state that owners have three interests: to earn the maximum profit under acceptable degrees of risk, to maximise their share of the profits, and to make the firm's stock freely marketable at a fair price. In contrast, a manager aims only to run the company for his own profit.1 Williamson (1975) noted that an agent acts out of self-interest and guile in pursuing his own goals, a mode of behaviour he termed "opportunism" which accounts for asymmetric information within the firm whereby the agent, who possesses greater information than the principal, is able to do anything for his own profit. There are many ways to align the interests of agents with the principals to reduce agency costs. Jensen and Meckling (1976) proposed increasing equity ownership by the firm's managers to tie their (managers) compensation to the performance of the firm. Fama (1980) showed that poor performance will negatively affect the manager's career opportunities in the managerial labour market. Grossman and Hart (1980) found that managers who do poorly will be replaced by better managers from a firm that buys or takes over the firm. Fama and Jensen (1983) called for strengthening the firm's board of directors to keep self-serving managers under control through audits and evaluations. Baysinger and Hoskisson (1990) argued for the hiring of outside directors to monitor the performance of executive directors. Rechner and Dalton (1991) suggested the separation of the titles and persons of the Chief Executive Officer (CEO) and the Chairman to prevent conflict of interest when the CEO represents both the shareholders and management. Family Ownership and Management of Firms Family firms should perform better than non-family owned firms, since a single block of owners, namely the family, exercises greater control over the managers who either belong to the family or are close to it and, therefore, align their interests more closely. According to agency theory, family-owned firms maximise value.2 Villalonga and Amit (2004), in answer to our question on how family firms compare in performance compared to non-family firms, posit three fundamental elements related to the firm value: ownership, control, and management. How does family ownership affect the value of the firm Berle and Means (1932) theorise that the concentration of ownership should increase value because it minimises conflict of interest between managers and owners. However, Demsetz (1983) counters that concentration of ownership is the endogenous outcome of profit-maximising decisions by current and potential shareholders and should have no effect on value. Empirical evidence supporting the latter view was shown by Demsetz and Lehn (1985), Himmelberg, Hubbard, and Palia (1999), and Demsetz and Villalonga (2001). In addition, Claessens, Djankov, Fan, and Lang (2002), Anderson and Reeb (2003), and Cronqvist and Nilsson (2003) studied the effect of ownership by families and other large shareholders, but as their studies do not separate family ownership from both family control and management, the effect of ownership on firm value cannot be ascertained conclusively. How does family control affect firm value Shleifer and Vishny (1986) tested individual and family controlled firms with a dominant majority shareholder and a small number of small shareholders. They concluded that the classic owner-manager conflict is diminished because the large shareholder has greater incentives to monitor the manager. However, they discovered a new form of agency problem where the dominant shareholder uses his power to extract private benefits at the expense of small shareholders, a phenomenon they describe as "expropriation". This abuse of power diminished firm value in the form of benefits flows to the dominant owner, to the disadvantage of minority owners. The study also revealed that if the large shareholder is an institution such as another widely held public corporation, an investment fund, or a bank, the private benefits of control are diluted among several independent owners, so the large shareholder's incentive for expropriation is small, resulting in diminished incentives to monitor the manager, and giving rise to the classic agency problem. But how do the two agency problems (classic and expropriation) affect firm value There is not enough evidence as to which is more disadvantageous. Claessens, et al. (2002) and Lins (2003) show that, in East Asian economies, the excess of large shareholders' voting rights over cash flow rights reduces the overall value of the firm, although not enough to offset the benefits of ownership concentration. Cronqvist and Nilsson (2003) find that in Sweden, it is cash flow ownership, not excess voting rights, that has a negative impact on value. Moreover, neither of these studies controls for the endogeneity3 of ownership and control, which earlier research shows is a major determinant of their effects on firm value (Demsetz and Villalonga, 2001). Further research needs to be done in this area to determine how agency cost and expropriation affect firm value. The third question is how family management affects firm value. In theory, family management diminishes or even eliminates agency costs and would therefore enhance firm value. However, poor family management may offset this, especially if hired professionals are better than family members or their descendants (Burkart, Panunzi, and Shleifer, 2003). Studies by Palia and Ravid (2002), Adams, Almeida, and Ferreira (2004), and Fahlenbrach (2004) show that firms managed by their founders have greater value compared to other firms. The stock market, however, brings down the value of a firm if family heirs are appointed into management (Smith and Amoako-Adu, 1999 and Perez-Gonzalez, 2001). A similar set of questions arises on firm value effect of the absence of the founder-CEO, a problem investigated by Villalonga and Amit (2004) who concluded that family ownership creates value if the founder is still active in the firm as CEO or Chairman with a hired outsider or non-family CEO. But when descendant-CEOs4 take over the firm, value diminishes even if the founder is still in the Board due to the classic agency conflict. Founding CEOs create the highest value when no control-enhancing mechanisms facilitate the expropriation of non-family shareholders through the use of multiple share classes with differential voting rights, pyramids, cross-holdings, or voting agreements. Descendant-CEOs destroy value whether or not the family has established control-enhancing mechanisms. Villalonga and Amit (2004) also conclude that value destruction applies only to second-generation CEO-heirs, and that as proven by recent cases5, post second generation descendant-CEOs contribute to value creation, pointing out the non-monotonic effect of generation on firm value. Other studies look at the quality of governance at family controlled corporations in several countries like high and middle-income countries (La Porta et al., 1999), East Asian countries (Claessens at al, 2000), India (Khanna and Palepu, 1997), Thailand (Wiwattanakantang, 2001), China (Chen and Strange, 2004), Japan (Nishioka and Baba, 2004), and Brazil (Valadares and Leal, undated), with mixed results. Private versus Public Firms Among the agency theory issues pointed out by Jensen and Meckling (1976) is that the value of the firm diminishes as the stakes of management decreases and the ownership base of the firm increases. However, Fama (1980) pointed out that since an efficient capital market signals the value of a firm's securities, public ownership should be a factor in monitoring and controlling the selfish motives of managers and, hence, partially resolve agency problems. Whether this is proven empirically in the case of the price performance of public and privately held firms remains an open question (Kwan, 2004). While evidence from previous empirical studies by Jensen and Warner (1988), Demsetz (1983), and Fama and Jensen (1983) showed that increased management ownership of the firm decreases the probability of diminishing firm value, they question the validity of their findings to the extent that ownership structure may depend on the characteristics of each industry, since their test sample included firms from different industries. Other papers by Holthausen and Larcker (1996), Jain and Kini (1994), and Mikkelson, Partch, and Shah (1997) study so-called endogenous events, like changes in ownership structure from leveraged buyouts and initial public offerings and their effects on firm performance, with similar results. What about the effect of an increase in the ownership base of the firm A new insight was given by Robert C. Merton: "Ceteris paribus, ... an increase in the relative size of the firm's investor base will reduce the firm's cost of capital and increase the market value of the firm. Thus, ... managers of the firm have an incentive to expand the firm's investor base."6 Merton proposed a model (1987) that attempted to determine whether the size of the firm's investor base is an important determinant of the firm value as reflected in the price of the firm's securities. Starting from the assumption that investors invest only in a limited set of securities about which they have information, he then suggested that securities markets may effectively be "segmented" - that is, companies lacking retail investors may be selling at a sharp "information discount" relative to their retail-owned counterparts. To the extent such segmentation exists - and this is still a matter of sharp contention - management actions that expand the firm's investor base would increase the firm's value. Merton's theory provides a rationale for the efforts of firms to increase share ownership: an increase in the number of investors holding the security should increase companies' values and, consequently, the stock price. Many papers studied the effects of increasing the investor base on the firm's value as reflected in the stock price. Amihud and Mendelson (1986) proved that a security's value is decreasing in its illiquidity costs, because investors require a compensation for these costs. The liquidity perspective suggests an additional test. Bagehot (1971), Kyle (1985), and Black (1986) found that increasing the number of shareholders is positively associated with investors' recognition, or awareness, of the stock and its liquidity. The two factors are intricately related because illiquidity is the direct result of asymmetric information problems. Other studies attempted to empirically prove the relationship between size of the investor base and stock prices. Amihud, Mendelson and Uno (1998) argued that there is a positive correlation between the increase in stock price due to an increase in the investor base brought about by a reduction in the minimum trading lots of listed stocks at the Tokyo Stock Exchange. Shing-yang Hu (1997), using trading turnover (based on 1976-1993 Tokyo Stock Exchange data) as a measure of liquidity, showed that , cross-sectionally, stocks with higher turnover tend to have a lower expected return, an evidence consistent with predictions derived from an Amihud-Mendelson transaction cost model in which the turnover measures investors' trading frequency. The trading frequency hypothesis also predicts that the cross-sectional expected return is a concave function of the turnover and the time-series expected return is an increasing function of the turnover. Stulz, Pirinsky, and Helwege (2005) found that a firm's stock market performance and trading play an extremely important role in its insider ownership dynamics, and that variables suggested by agency theory have limited success in explaining the evolution of ownership. To go around these limitations, Kwan (2004) focused his study on a single industry and investigated the performance of private and public bank holding companies (BHCs), thereby controlling the effect of industry characteristics on ownership structure. Since all the firms in his study operate with presumably similar production functions, ownership structure can be viewed as an exogenous variable, after controlling for firm size, making his study contribute to the field by isolating the ownership effect more accurately. Analysing three areas of performance - profitability, operating efficiency, and risk taking - of BHCs, he conducted a straightforward test of the agency theory and concluded that results are consistent with the theory that separating ownership from control leads to shirking and perquisite consumption by management, thereby compromising operating efficiency and profitability. The study also supported the prediction that publicly held companies are more risk averse as evidenced by the tendency of publicly held BHCs to hold significantly more capital. Risk aversion in widely held public firms therefore fail to maximise firm value, a finding that goes against Merton's 1987 proposition. Other issues In asking how the interests of owners and managers can best be aligned, agency theory assumes the opposite of what economists previously thought. Agency theory, grounded on the self-interest of non-owner CEOs and other managers, appears to suggest that managers are bad (Ong and Lee, undated). In reality it is possible that as managers contribute their scarce human capital to the organization, they can be equally, if not more, concerned with the success of the company as the owners. Managers will therefore reduce agency costs and poor firm performance on their own accord. Agency theory assumes that people are individualistic and self-serving. Jensen and Meckling (1994) criticized this model of man as being a simplification for mathematical modelling and an unrealistic description of human behaviour. Doucouliagos (1994) also argued that labelling all motivation as self-serving does not explain the complexity of human action. Frank (1994) suggested that this model of man does not suit the demands of a social existence. Man takes care of both his personal and social needs at the same time; he may be self-interested, but not selfish. As self-interest can be sacrificed for the sake of the organization, in broad-brushing reality in exchange for simplicity and elegance in their models, agency theory assumptions may limit its generalisability (Hirsch et al., 1987). A recent book (Tirole, 2006) provides insights that give new importance to agency theory in helping economists gain a much better grasp of which mix of incentives and monitoring is likely to work best in different circumstances. Conclusions Agency Theory and Family Ownership A review of the related literature (Table 1) on the theoretical and empirical study of agency theory and ownership structure as applied to family ownership, management, and control show that while these can help maximise firm value in support of agency theory, this result is dependent on the presence and active participation of a founder-CEO, even after retirement. The effect of a second generation CEO-heir gives the opposite result, i.e., firm value diminishes. This factor was found to be non-monotonic, which explains why firm performance can improve even if a CEO-heir is appointed beyond the second generation. There is need, however, for more research in the area of dealing with a second dimension of the agency problem called "expropriation" and to compare this with the classic agency problem to find out which is more disadvantageous to minority owners and how negative effects of both can be minimised in a firm dominated by a majority owner. Agency Theory and Public/Private Ownership We reviewed theoretical and empirical studies on how agency theory explains public and private firm performance (Table 2). We conclude that although there is evidence that both firm performance and value increase with an increase in management ownership, it can also decrease with widening of ownership consistent with key findings of incentive dispersal for management monitoring and control. Present studies have limited validity due to the endogeneity of industry characteristics on firm performance. A focused study limited to the banking industry, however, proved that the behaviour of firm performance supports agency theory. Further studies on different industries should monitor their behaviour with changes in ownership structure to control the effects of endogenous factors. Agency Theory and Widening Ownership Base In relation to the effect of widening ownership structure on firm value, evidence is inconclusive with findings (see Table 3) in support of either hypothesis. Although there is evidence that firm value increases with wider firm ownership, this may not be due to the alignment of the interests of owners and managers but explained by increased liquidity in the market and the market's perception of expected returns. Further research focused on firm behaviour due to ownership changes in specific industries will help understand how the value of the firm can be maximised. Footnotes Reference List Adams, R. B., Almeida, H. & Ferreira, D. (2004). Understanding the relationship between founder-CEOs and firm performance. Working paper, New York University. Amihud, Y. & Mendelson, H. (1986). Asset pricing and the bid-ask spread. Journal of Financial Economics 17, 223-249. Amihud, Y., Mendelson, H. & Uno, J. (1998). Number of shareholders and stock prices: evidence from Japan. New York University Salomon Center for Research in Financial Institutions and Markets, Working Paper S-98-34. Anderson, R. & Reeb, D.M. (2003). Founding family ownership and firm performance: evidence from the S&P 500. Journal of Finance 58, 1301-1329. Bagehot, W. (1971). The only game in town. Financial Analysts Journal 27, March-April: 12-14. Baysinger, B.D. and Hoskisson, R.E. (1990). The composition of boards of directors and strategic control: effects on corporate strategy. Academy of Management Review, 15, 72-87. Berle, A.A. and Means, G.C. (1932). The modern corporation and private property. New York: MacMillan. Black, F. (1986). Noise. Journal of Finance 41, 529-543. Brealey R. and Myers S. (1996). Principles of Corporate Finance. 5th ed. New York: McGraw-Hill. Burkart, M., Panunzi, F. & Shleifer, A. (2003). Family firms. Journal of Finance 58, 2167-2202. Chen, J. & Strange, R. (2004). The effect of ownership structure on the underpricing of initial public offerings: evidence from Chinese stock markets. The Management Centre Research Paper 029. Claessens, S., Djankov, S., & Lang, L.H.P. (2000). Separation of ownership from control of East Asian firms. Journal of Financial Economics 58, 81-112. Claessens, S., Djankov, S., Fan, J.H.P. & Lang, L.H.P (2002). Disentangling the incentive and entrenchment effects of large shareholdings. Journal of Finance 57, 2741-2772. Cronqvist, H. & Nilsson, M. (2003). Agency costs of controlling minority shareholders, Journal of Financial and Quantitative Analysis 38, 695-719. Demsetz, H. (1983). The structure of ownership and the theory of the firm. Journal of Law and Economics 26, 375-390. Demsetz, H. & Lehn, K. (1985). The structure of corporate ownership: causes and consequences. Journal of Political Economy 93, 1155-1177. Demsetz, H. & Villalonga, B. (2001). Ownership structure and corporate performance. Journal of Corporate Finance 7, 209-233. Doucouliagos, C. (1994). A note on the evolution of homo economicus. Journal of Economics Issues, 3, 877-883. Faccio, M. & Lang, L.H.P. (2002). The ultimate ownership of Western European corporations. Journal of Financial Economics 65, 365-395. Fahlenbrach, R. (2004). Founder-CEOs and stock market performance. Working paper, Wharton School, University of Pennsylvania. Fama, E.F. (1980). Agency problems and theory of the firm. Journal of Political Economy, 88, 2, 288-307. Fama, E.F. and Jensen, M.C. (1983). Separation of ownership and control. Journal of Law and Economics, 26, 301-324. Frank, R.H. (1994). Microeconomics and behaviour. New York: McGraw-Hill. Grossman, S. and Hart, O.D. (1980). Takeover bids, the free-rider problem and the theory of the corporation. Bell Journal of Economics, 11, 42-64. Himmelberg, C. P., Hubbard, R.G. & Palia, D. (1999). Understanding the determinants of managerial ownership and the link between ownership and performance. Journal of Financial Economics 53, 353-84. Hirsch, P., Michaels, S., & Friedman, R. (1987). 'Dirty hands' versus 'clean models'. Theory and Society, 16, 317-336. Holthausen, R. & D. Larcker. (1996). The financial performance of reverse leveraged buyouts. Journal of Financial Economics 42, no. 3 (November): 293-332. Hu, S.Y. (1997). Trading turnover and expected stock returns: the trading frequency hypothesis and evidence from the Tokyo Stock Exchange. Economics Working Paper ewp-fin/9702001. Jain, B. A., & O. Kini. (1994). The post-issue operating performance of IPO firms. Journal of Finance 49, no. 5 (December): 1699-1726. Jensen, M.C. and Meckling, W.H. (1976). Theory of the firm: Managerial behaviour, agency costs and ownership structure. Journal of Financial Economics, 3, 305-360. Jensen, M.C. & Meckling, W.H. (1994). The nature of man. Journal of Applied Corporate Finance, 7: 2, 4-19. Jensen, M. & Warner, J.B. (1988). The Distribution of Power among Corporate Managers, Shareholders, and Directors. Journal of Financial Economics 20, 1-2: 3-24. Khanna, T., and Palepu, K. (1997). Why focused strategies may be wrong for emerging markets. Harvard Business Review 75 (4): 41-51. Kwan, S. (2004). Risk and return of publicly held versus privately owned banks. Federal Reserve Bank of New York Economic Policy Review, September 2004, 97-107. Kyle, A. P. (1985). Continuous auctions and insider trading. Econometrica 53, 1315-1336. La Porta, R. and Lopez-de-Salinas, F. (1999). The benefits of privatization: evidence from Mxico. Quarterly Journal of Economics 114 (4): 1193 - 1242. La Porta, R., Lopez-De Salinas, F.& Shleifer, A. (1999). Corporate ownership around the world. Journal of Finance 54, 471-517. Lins, K.V. (2003). Equity ownership and firm value in emerging markets. Journal of Financial and Quantitative Analysis 38, 159-184. Merton, R. C. (1987). A simple model of capital market equilibrium with incomplete information. Journal of Finance 42, 483-511. Mikkelson, W. H., Partch, M.M. & Shah, K. (1997). Ownership and operating performance of companies that go public. Journal of Financial Economics 44, no. 3 (June): 281-307. Millimet, D. (2001). "What is the difference between endogeneity and sample selection bias" Stata Statistical Software for Professionals. Updated 2006. Retrieved 14 February 2006, from http://www.stata.com/support/faqs/stat/bias.html Nishioka, S. & Baba, N. (2004). Dynamic capital structure of Japanese firms: how far as the reduction of excess leverage progressed in Japan Bank of Japan Working Paper No. 04-E16. Ong, C.H. & Lee, S.H. (Undated). Board functions and firm performance: a review and directions for future research. Journal of Comparative International Management. Retrieved 16 February 2006, from http://www.lib.unb.ca/Texts/JCIM/bin/get.cgidirectory=vol3_1/&filename=haut.htm Palia, D. & Ravid, S.A. (2002). The role of founders in large companies: entrenchment or valuable human capital Working paper, Rutgers University. Prez-Gonzlez, F. (2001). Does inherited control hurt firm performance Working paper, Columbia University. Rechner, P.L. and Dalton, D.R. (1991). CEO duality and organizational performance: A longitudinal analysis. Strategic Management Journal, 12, 155-160. Shleifer, A. & Vishny, R. (1986). Large shareholders and corporate control. Journal of Political Economy 94, 461-488. Smith, B. F. & Amoako-Adu, B. (1999). Management succession and financial performance of family controlled firms. Journal of Corporate Finance 5, 341-368. Stulz, R., Helwege, J., & Pirinsky, C. (2005). Why do firms become widely held An analysis of the dynamics of corporate ownership. July 2005, Working Paper. University of Arizona. Tirole, J. (2006). The theory of corporate finance. Princeton: Princeton University Press. Valadares, S. M. & Leal, R.P.C. (Undated). Ownership and control structure of Brazilian companies. Universidade Federal do Rio de Janeiro Working Paper. Villalonga, B. & Amit, R. (2004). How Do Family Ownership, Control, and Management Affect Firm Value August 2004, Working Paper. Harvard Business School. Williamson, O. (1975). Markets and hierarchies. New York: Free Press. Wiwattanakantang, Y. (2001). Controlling shareholders and corporate value: evidence from Thailand. Pacific Basin Finance Journal 9: 323 - 62. Table 1. Agency Theory and Family Ownership Theoretical Empirical Concentration of ownership should increase value. (Berle & Means, 1932) Ownership concentration as endogenous outcome with no effect on value. (Demsetz, 1983) Supported by Demsetz & Lehn, 1985; Himmelberg, Hubbard, & Palia, 1999; and Demsetz & Villalonga, 2001. Effect of family ownership on firm value cannot be ascertained conclusively. (Claessens, Djankov,Fan, and Lang, 2002), Anderson and Reeb (2003), Cronqvist and Nilsson (2003). Classic owner-manager conflict is diminished, but creating a new form of agency problem (expropriation). (Shleifer & Vishny, 1986) Inconclusive evidence in East Asian economies (Claessens et al., 2002) and in Sweden (Cronqvist & Nilsson, 2003). Need to control variables of endogeneity of ownership and control (Demsetz & Villalonga, 2001). Poor family management may offset positive effects of eliminating agency costs (Burkart, Panunzi, & Shleifer, 2003) Firms managed by founders have greater value compared to other firms. (Palia & Ravid, 2002; Adams, Almeida, & Ferreira, 2004; Fahlenbrach, 2004) Firm value goes down with appointment of heirs. (Smith & Amoako-Adu, 1999; Perez-Gonzalez, 2001) Family ownership creates value if CEO-founder is active in firm management but diminishes when he is absent. (Villalonga & Amit, 2004) Quality of governance at family controlled corporations show mixed results. (La Porta et al., 1999; Claessens et al., 2000; Khanna & Palepu, 1997; Wiwattanakantang, 2001; Chen & Strange, 2004; Nishioka & Baba, 2004; Valadares & Leal, undated). Table 2. Agency Theory and Public/Private Ownership Theoretical Empirical Firm value diminishes as management stakes decrease and ownership increases. (Jensen & Meckling, 1976). An efficient capital market signals the value of a firm's securities, so public ownership should resolve agency problems and increase firm value. (Fama, 1980) Price performance of public and privately held firms is still an open question (Kwan, 2004). Probability of diminishing firm value decreases with increased management ownership, but validity is questionable due to endogeneity of industry characteristics. (Jensen & Warner, 1988; Demsetz, 1983; Fama & Jensen, 1983) Firm value increases with public ownership based on endogenous events like LBOs and IPOs. (Holthausen & Larcker, 1996; Jain & Kini,1994; and Mikkelson, Partch, & Shah, 1997). Firm's stock price play an important role in its insider ownership dynamics, and agency theory have limited success in explaining the evolution of ownership. (Stulz, Pirinsky, & Helwege, 2005) Limiting the study to one industry shows that firm performance supports agency theory. (Kwan, 2004) Table 3. Agency Theory, Ownership and Firm Value Theoretical Empirical Size of investor base is an important determinant of stock price and firm value. (Merton, 1987) There is a positive correlation between increase in stock price and increase in investor base in the Tokyo Stock Exchange. (Amihud, Mendelson, & Uno, 1998). Increasing the number of shareholders is positively associated with investors' recognition, or awareness, of the stock and its liquidity. (Bagehot, 1971; Kyle, 1985; Black, 1986) Stocks with higher turnover and higher liquidity have lower expected returns. (Hu, 1997) Read More