In praise of concentrated ownership

Around 10-15% of large and mid-cap stocks selected from developed markets in North America, Europe and Australia are still run by the founder, where they occupy one of more of the following: CEO, Chairman or Board director.  Drawing on key insights from journal research and our own empirical research, the performance, valuation and characteristics of these entrepreneurial firms are distinct from heir controlled firms and other firms.

Most of the journal research on founder firms has been undertaken under the umbrella of firms controlled by families and individuals.  Studies in the past two decades document that the incidence concentrated ownership of listed firms globally is surprisingly high: 30% of large firms in developed economies are controlled by families or individuals, over 40% of firms in Western European countries are family controlled, more than two thirds of firms in nine East Asian countries are controlled by families or individuals, and founding families control at least one-third of publicly held firms in the S&P 500.

Monitoring benefits Vs. entrenchment costs

The prevalence of founder and family controlled firms globally suggests there are tangible benefits from highly concentrated share ownership.  There are two schools of thought regarding ownership concentration and firm value and performance; one argues that large shareholders enhance monitoring of managerial performance, while the entrenchment view suggests that large shareholders expropriate corporate resources from minority shareholders.  We look to the theory and empirical evidence for guidance on the link between ownership structure and firm performance.

Growing complexity has lifted monitoring costs

It has long been recognised that the separation of ownership from control of corporate assets gives rises to agency problems.  At the heart of the classic agency conflict are two dimensions: moral hazard and information asymmetries between the principal (shareholders) and agents (managers).  Moral hazard arises when agents do not bear the full costs of their decisions which provide incentives to engage in behaviour not in the interests of the principal.  Information asymmetries are important because it can be difficult and costly for shareholders to monitor and evaluate managerial performance.  Two trends have exacerbated monitoring costs and information asymmetries more broadly: the growing size of firms and increased complexity of decision making necessary to manage modern corporations and diffuse shareholder ownership.

Diffuse share ownership reduces monitoring incentives

Diffuse shareholder ownership promotes risk sharing diversification.  But a broad ownership base reduces monitoring incentives because of the free rider problem.  Monitoring a managerial performance is costly process in terms of both money and time expended.  Those who engage in monitoring incur significant costs but the benefits are spread across all shareholders.  The incentives for shareholders to engage in monitoring are further weakened by the fact that many own well diversified portfolios.  In their seminal analysis published in 1932, The Modern Corporation and Private Property, Adolf Berle and Gardiner Means argue that diffuse share ownership is associated with poor firm performance due to the absence of effective monitoring.  They view the key benefit of ownership concentration in the form of one or multiple large shareholders, as overcoming the free rider problem.  The presence of a large shareholder who is the firm’s entrepreneur-founder offers a potential resolution to the classic agency problem because she has a strong incentive to monitor managerial decision making.