The Principle of Proportionality: Separating the Impact of Dual Class Shares, Pyramids and Cross-ownership on Firm Value Across Legal Regimes in Western Europe

Recent policy initiatives within the harmonization of European company laws have promoted a so-called “principle of proportionality” through proposals that regulate mechanisms opposing a proportional distribution of ownership and control. We scrutinize the foundation for these initiatives by analyzing the use of instruments to separate ownership from control across legal regimes in a sample of over 4,000 publicly traded firms from 14 Western European countries. First, we confirm the negative impact on firm value from disproportional ownership structures previously established in a sample of Asian firms by Claessens et al. (2002). Second, we show that dual class shares have a larger and more significant negative effect on firm value than pyramids and cross holdings. Third, we find that the impact of disproportionality and the underlying instruments is inversely related to the level of investor protection. Thus, dual class shares and pyramids substitute legal protection in countries with inadequate investor protection. Fourth, we find no evidence of a significant effect of disproportionality instruments on earnings performance. Finally, we discuss policy implications of these findings in relationship to the process of harmonization of the European capital markets.ownership structure; dual class shares; pyramids; EU company laws

Incentive and Entrenchment Effects in European Ownership

In a large sample of European firms we analyze the value discount associated with disproportional ownership structures first documented by Claessens et al (2002). Consistent with a theoretical model of incentives and entrenchment effects, we find higher value discount in family firms, in firms with low cash flow concentration, and in industries with higher amenity value. Furthermore, the discount is higher in countries with good investor protection and higher for dual class shares than for pyramids. We find no impact on operating performance, likelihood of bankruptcy, dividend policy, or growth. Finally, we discuss policy implications of these findings.Ownership Structure, Dual Class Shares, Pyramids, EU Company Law

Private Contracting and Corporate Governance: Evidence from the Provision of Tag-Along Rights in an Emerging Market

We analyse controlling owners incentive to provide non-controlling owners with better protection against self-dealing through offering new shares with tag-along rights, - the private contracting alternative to equal price provision in takeover legislation. Our model identifies two counteracting effects: The benefit of offering tag-along rights is the anti-expropriation effect which makes it harder for new owners to finance a takeover through expropriation of minority owners. The cost is the rent transfer effect which implies that there is a wealth transfer from controlling owners to existing minority owners. Empirically we test the implications of the model using data on equity offerings in Brazil. Consistent with the theoretical predictions we find that offering tag-along rights increases market value of a firm and that companies offering shares with tag-along rights offer larger claims, have less disproportional ownership structure, have a smaller group of existing minority shareholders and are more likely to issue new shares. The paper, thus, find strong support for private contracting being an important alternative governance mechanism to legal protection of investors.Private contracting, Corporate governance, Emerging markets, Tag-along rights

Board Size Effects in Closely Held Corporations

Previous work on board size effects in closely held corporations has established a negative correlation between board size and firm performance. We argue that this work has been incomplete in analysing the causal relationship due to lack of ownership information and weak identification strategies in simultanous equation analysis. In the present paper we reexamine the causal relationship between board size and firm performance using a dataset of more than 5,000 small and medium sized closely held corporations with complete ownership information and detailed accounting data. We test the potential endogeneity of board size by using a new instrument given by the number of children of the founders of the firms. Our analysis shows that board size can be taken as exogenous in the performance equation. Furthermore, based on a flexible model specification we find that there is no empirical evidence of adverse board size effects in the typical range of three to six board members. Finally, we find a significantly negative board size effect in the minority of closely held firms which have comparatively large boards of seven or more members.

TMB: Automatic Differentiation and Laplace Approximation

TMB is an open source R package that enables quick implementation of complex nonlinear random effect (latent variable) models in a manner similar to the established AD Model Builder package (ADMB, admb-project.org). In addition, it offers easy access to parallel computations. The user defines the joint likelihood for the data and the random effects as a C++ template function, while all the other operations are done in R; e.g., reading in the data. The package evaluates and maximizes the Laplace approximation of the marginal likelihood where the random effects are automatically integrated out. This approximation, and its derivatives, are obtained using automatic differentiation (up to order three) of the joint likelihood. The computations are designed to be fast for problems with many random effects (~10^6) and parameters (~10^3). Computation times using ADMB and TMB are compared on a suite of examples ranging from simple models to large spatial models where the random effects are a Gaussian random field. Speedups ranging from 1.5 to about 100 are obtained with increasing gains for large problems. The package and examples are available at http://tmb-project.org