Ownership Structure and Financial Performance - Essay Example

Ownership Structure and Financial Performance The basic aim of the paper is to conduct a detailed exploring the impact of ownership structure on firm’s performance. In order to develop a discussion on this relation corporate governance practices from two Anglo-American countries that are UK and US have been discussed. In this regard, firstly the paper examines the dimensions of ownership structures. Ownership structure is distinguished on the basis of two measures including ownership identity and ownership concentration. Ownership identify is related to the real owners of the business and ownership concentration reflects the proportion of voting shares held by owners of the business. Moreover, the paper talks about the measurement of the ownership structures with respect to financial performances and finally generates an understanding of US and UK based companies by distinguishing them on the basis of ownership identities and level of concentration. The development in corporate governance practices and regulations pertaining to disclosures of ownership are also discussed. Various measures of financial performance are highlighted and discussed in relation with the research topic. It has been concluded that ownership structure has an impact on financial performances, but with varying interests as there are other internal and external factors that may play a vital role in reducing or increasing productivity. Moreover, it has been identified in this report that the relationship between ownership structure and financial performance of firms is not observed to have a similar trend in different countries. Ownership Structure and Financial Performance Corporate governance comprises of control mechanisms through which corporations are governed and directed to perform their duties effectively. The ownership structure needs to be directed by corporate governance because lack of transparency of ownership structure may have an adverse impact on financial performances. In other words, it can be said that ownership structure shows the types and compositions of different shareholders that have an influence on company’s key decisions areas so they need to be administered by corporate governance in order to carry out their processes in ethical and transparent manner (Solomon, 2007, p. 137). The purpose of this paper is to generate an understanding of the relationship of ownership structure and company’s performance. In this regard, investigation of UK and United companies is carried out in this paper. Organizational structure can either be government based or privatized. Each one of them has distinct characteristic features that have a considerable amount of impact on the management of the company as well as the on the employees. They have varied the impact of ownership structures though some scholars have the view that there is more positive effect of ownership structure on private firms’ performance rather than state-owned companies (Varcholova & Beslerova, 2013). Ownership structure still contains some postulation that there is an internal cause, which makes it inclination towards profit margins so whether it is state owned or privatized they would still aim towards productivity. On the other hand, ownership structure consists of two main dimensions: ownership identity and ownership concentration. They show the extent to which owners have the means to exercise their control over activities of the managers and the company. Even though ownership gives them power to expand, but with respect to ownership identity, research indicates that they create information asymmetry that may influence a company to take risks and improve financial performance. It may also give rise to conflicts between the owners and management depending on the nature of ownership identity (Morck, Shleifer, & Vishny, 1988). Ownership identities may be of different types. They can be institutional or government investors so it is important to know the nature of ownership identities and the level of involvement in the company’s key decision areas. Family companies are seen behind productivity as compared to other firms. However, if they are given ownership they can perform better as it would lead to more knowledge as managers will have many options to make their decisions. Moreover, as family firms are seen more inclined towards global expansion it shall be beneficial and proven to give better financial performances (Zahra, 2003). In the case there are more insider shareholders then it is important to determine how much power they have within the company to exercise their authority. Though, the presence of insider shares may reduce agency costs but they still manage to exercise power (Anderson & Reeb, 2003). However, government bodies have the means to exercise control on the property as well to regulate state policy giving rise to political issues. In most of the companies in UK, United States or other countries higher ownership of government diverts attention from profit to other interests. It can be said that they may be more focused to gain political benefits and may not look at financial returns for the company. Most of their interests lie on political such as having fewer prices, employment issues, etc. so they have a negative link with financial performances (Boycko, Shleifer, & Vishny, 1996). It is still important to state that government intervention in terms in ownership is mostly carried to prevent job losses, but nonprofit maximizing scheme of the government gives rise to poor performances of the company. Other companies, on the other hand, hold corporate shares, thus, the financial performances in this type of ownership shall solely depend on the performances of that company. Likewise, investment banks that look at long-term returns and not day-to-day transactions basically hold Institutional shares. However, in order to determine their involvement in activities of the company their nature of working needs to be scrutinized (Ben-Amar & & Andre, 2006). As far as ownership concentration is concerned, when shareholder’s control is concentrated, then company may have more authoritative control over their share but it may also have a negative impact on product diversification (Hill & Snell, 1989). Thus, the company’s financial performance may vary in different circumstances. Moreover, even though the companies can be managed more effectively through concentrated power but it is seen that they mostly take away the control from minority shareholders, expropriating their values. If there is diffused ownership structure that protects minority shareholders may play a positive role in productivity, reducing risk and making financial performances better (La Porta, Lopez-de-Silanes, & Shleifer, 1999). At this point of time, it depends on the rules of the country that how they safeguard the interests of the minority shareholder whether it is United States, United Kingdom or any other country of the world. In an ongoing debate to determine the relationship ownership structure with financial performances, different measurement scales are used for instance return on assets (ROA), return on Equity (ROE) and Tobin Q. These scales demonstrate the correlation between ownership identities and concentration on financial performances. With respect to Tobin Q some scholars state that there is a curvilinear relationship between them whereas some say that there is inconclusive feedback (Wolfe & Aidar Sauaia, 2003). Likewise, return on assets ratio can show the returns by looking at the profitability margins. However, scholars also feel that ROA ratio may not always indicate if there will be higher returns or if one should invest in the business because the focus is only on fixed assets and many other factors like ideas and innovation are neglected. At the same time, ROA ratios shows that if there is more ROA, it can drive individuals towards better investment plans and increase financial performances for the company (Himmelberg, Hubbarda, & Paliaa, 1999). Return on equity (ROE) provides measurement of financial performances and is closely linked with ownership structure because when there are institutional investors and foreign it is seen that there are more ROEs (Chaganti & Damanpour, 1991), (Harris & Robinson, 2003). However, management can show wrong ROEs especially when the performances of the company deteriorate which could further complicate issues. Reliability and transparency in ownership structure, showing their exact financial condition can play a vital role in sustaining good financial performances. In United States, Acts of 1933 and 1934 show how investors’ interests are protected as they use diffused stockholding. Most of the UK and US based companies make effective use of the benefits of low concentration of ownerships (Thomsen & Pedersen, 1997). There are also many investors acting as the sole owners. However, in United States, there is no entrenchment faced by corporation even when the ownership structure is concentrated and the reason being that there Sarbanes-Oxley Act which is supposed to show transparency of agency costs firms (Fauzi & Locke, 2012, p. 44).US based firms still face a problem of protecting interests of shareholders and monitoring performances of the company because of competition in the environment so they require control mechanisms like board structure, capital structure, insider ownership and block ownership (Fauzi & Locke 2012, p. 44). In US, most of the companies prevent controlling stakes in order to promote asset diversification. Foreign-owned companies in United States as well as in UK are seen prospering as there are many advantages of foreign direct investments (FDI). They can join hands with local industries and also mingle with the domestic market to increase financial performance. The plants that are owned by foreign countries perform better due to the same reason that they are offshoots of FDI. It makes the domestic plants less productive (Harris R. &., 2003). Thus, most of the US firms are seen having an ownership that is simple and flat whereas some are complex. However, most importantly mostly are operating in foreign companies through FDI. As far as the level of diffuseness or concentration is concerned US is one of the countries which is internationally recognized as one of the broadest as well as fairest country to exercise their ownership rights as compared to other countries like Japan, Germany and Switzerland (Bhide, 1994) and one of the main reason behind this is that they are making use of effective corporate governance that regulate their working as well as protect the interests of its shareholders. The diffused ownership being exercised in United States also reduces dialogue amongst the shareholders and management of the company making them less likely to carry out unscrupulous trading practices. In other words, it can be said that when there is less disclosure of insider traders to the management then there are less financial panics, cheats as well as frauds and ownerships interests are safeguarded (Bhide, 1994). In US, the SEC regulations provide diversified set of rules through which companies are supposed to divide their portfolios. These underlying rules have an impact on transient outsiders having many stocks. If they are unhappy with their management, they sell their stocks when the need arises showing how firm’s performance is influenced by its ownership structure and how these firms react in different situations. If ownership structures are compared with UK based companies, it is seen that most of the ownership structures are not being consistently exercised with respect to value maximization principles. Most of the time, a major or the dominant shareholders are seen destroying the share value. Even when there is corporate governance, many firms in UK and other European countries like Spain have the dominant block holder that would get more benefit especially with regard to diversified products. The corporate owners are seen investing more projects within their country for higher paybacks to their shareholders. Surprisingly, these findings contradict as there are also other reports that state that ownership arrangements are consistent with value maximization (Grant & Kirchmaier, 2004). However, in UK most of the companies have low ownership concentration levels as well. In 2013, David Cameron announced a new policy that involves complete transparency of ownership through which public can access details regarding ownership structure (Palmer & Sharpe, 2014). It removes anonymity and ambiguous ownership names through which companies hide their wealth. Moreover, it builds a relationship of owner with its stakeholders that may have a positive impact on the company’s financial performances (Rosea, Mazzab, Normanc, & Rosea, 2013). Thus, it can be said that the relationship of ownership structure with the company’s performance can be positive or negative depending on the nature of ownership structure (with regard to identity and concentration levels). It also depends on other factors such as competition and pressures of external environment and role of government agencies (Ben-Amar & & Andre, 2006). Many European countries including UK show the same variable pattern of impact of ownership structures. Small family companies are seen taking fewer risks as compared to formal companies even when the demand is high making their performances better. Bigger companies are seen taking more risks with regard to their investment in high demand, which may treat their ongoing success rate (Cucculelli, 2009). In the end, it can be concluded that ownership structure has a significant amount of impact on company’s performances whether they are UK or US based companies. However, it is important that the focus is on corporate governance and reforms that ensure its monitoring, showing effective flow of funds incorporation with the dilution of ownership concentration. Moreover, it is important to state that it is not just the owners who are investing in the companies rather there are other stakeholders like employees, distributors as well as customers who provide a valuable contribution in a company so they also are involved in determining the financial performances of the organizations. 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