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    CESIS Electronic Working Paper Series

    Paper No. 197

    R&D, Corporate Governance and Profitability of Firms

    a literature review

    Daniel Wiberg

    (CESIS, JIBS)

    September 2009

    The Royal Institute of Technology

    Centre of Excellence for Science and Innovation Studies (CESIS)http://www.cesis

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    R&D,CorporateGovernanceandProfitabilityofFirms

    aLiteratureReview

    DanielWiberg

    JnkpingInternationalBusinessSchoolandCentreofExcellenceinScienceandInnovations

    Studies(CESIS),theRoyalInstituteofTechnology.

    VisitingAddress:Gjuterigatan5,P.O.Box1026,SE55111Jnkping

    Telephone:+4636101766

    Fax:+4636121832

    Email:[email protected]

    ABSTRACT

    Thispaperaims toprovidea summarize reviewof recent empirical research, in the fieldof

    corporategovernanceanditsrelationtoperformanceoffirms.Specifically,thefocusisonthe

    role of institutional owners in the conflictbetween controlling shareholders andminority

    owners.Thepaperalsocontributestotheliteratureoncorporategovernanceandperformance

    byprovidingsomediscussiononthestatisticalmethodsusedinmostempiricalinvestigations.

    Summinguprecentstudiesintheevaluationoffirmsinvestmentperformancehasshown

    significantdifferences in the valuation of firms,depending on themarket expectations and

    industryaffiliation.Focusingontheroleofinstitutionalownersinrelationtofirmsinvestment

    performance,theexistingempiricalevidencesuggestthatinstitutionalownershaveapositive

    influence on firms investment performance. Studies that looks at the role of institutional

    ownersfromtheperspectiveofdividendpolicyhasshownthatinstitutionalownersdemandhigher dividends to compensate for aggravated agency conflicts due to votedifferentiated

    shares. A large body of research investigates the performance of firms from a long run

    perspective.Thesestudiesdemonstratethatprofitsconvergeovertime,buttheconvergenceis

    incomplete. Investment inR&D isoftenput forwardasanexplanation forpersistentprofits

    above the norm. Looking at individual mutual funds, and specifically how to measure

    riskadjustedperformance, investigationsgenerallyshowthatmutual fundsunderperform in

    relationtotheirmarketbenchmark,evenwhenriskadjustedtothesamelevelofrisk.

    JELcodes:G30,C23,L25

    Keywords:CorporateGovernance,InvestmentPerformance,Investment,Institutions

    Acknowledgment: FinancialsupportfromTorsten&RagnarSderbergsFoundationis

    gratefullyacknowledged,togetherwitharesearchgrantfromtheCentreforExcellencefor

    ScienceandInnovationStudies(CESIS).TheauthorwouldalsoliketothankTheSwedish

    FoundationforInternationalCooperationinResearchandHigherEducation(STINT)fora

    generousvisitingresearcherscholarshiptoNationalSunYatsenUniversity,Taiwan.

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    1. INTRODUCTION

    During recent decades the worlds financial markets have seen an ongoing increase in

    institutionalownershipofcapital.Dotheseinstitutionalownersbehavedifferentlyfromother

    owners, and what are the consequences on firm performance? Do research in corporategovernanceprovidetheanswers?Theseissues,andspecificallyhowtheincreasinginstitutional

    ownershiphasaffectedinvestmentperformanceinlistedfirms,aredealtwithinthispaper.

    The roleof the financialmarket is to transfersavings to investors,andestablish relative

    pricesthatserveassignalstoguidetheallocationofcapital.Theefficiencyofthisallocationis

    an essential force in the creation ofwealth and economic growth.At the same time, this

    allocationmechanismistheresultofdecisionstakenbyindividualsorbypeopleappointedto

    act on theirbehalf.Of particular interest therefore are the formal and informal rules that

    surroundandaffect thisallocationprocess, that is, thecorporategovernancesystem.Witha

    focusonshareholdervalueDenisandMcConnell(2003,p.2)definecorporategovernanceas:

    thesetofmechanismsbothinstitutionalandmarketbasedthatinducetheselfinterested

    controllersofacompany(thosethatmakedecisionsregardinghowthecompanywillbeoperated)

    tomakedecisionsthatmaximizethevalueofthecompanytoitsowners(thesuppliersofcapital).

    Moregenerallycorporategovernancecanbedescribedasthesetofprocesses,customs,policies,

    lawsandregulationsthataffectthewayacorporationisadministeredandcontrolled.1 Itcan

    thenbeseparatedintothreeintertwinedthemes.Thefirstthemeconcernstheaccountabilityof

    certain actors in an organisation and the mechanisms used to reduce or eliminate the

    principalagent problem. A second theme of corporate governance, much related to the

    principalagentproblem,dealswith the impactof certain corporate governance systems on

    economicefficiency,oftenwithastrongemphasisonshareholderswelfare.Thethirdthemeof

    corporategovernanceconcernstheroleplayedbydifferentcorporategovernancestructuresin

    associationwithallparties related to thecorporation, thesocalledstakeholderview.Witha

    strongemphasisonthefirsttwofieldsofcorporategovernancethispaperaimstosummarizethe existing empirical evidence on the relationships between corporate governance,

    institutionalownership,andfirmperformance.

    FollowingJensen andMecklings (1976) seminal article on the conflict arising from a

    separationofownership and control,2 corporategovernance research conductedmainlyon

    largeUS firms, has focused on the conflictbetweenmanagers and dispersed shareholders

    (Maury,2004).3Acommonassumptioninmanystudiesisthattheprincipalgoalofcontrolling

    shareholdersistomaximizeshareholdervalue(Short,1994).Ifthisassumptionholdstruemore

    concentrated ownershipwill imply improved performance, sincemanagers are less free to

    pursue theirowngoalswhenacontrollingshareholderactsasmonitor(ShleiferandVishny,

    1 Foracomprehensivesurveyofcorporategovernance,seeShleiferandVishny(1997).2 TwohundredyearspriortoJensenandMeckling(1976)AdamSmith(1776)notedtheproblemsofaseparationof

    ownershipfromcontrol.AmoreindepthanalysisofthediffusionofownershipwasthenprovidedinBerleandMeans

    (1932)classicalbookTheModernCorporationandPrivateProperty.3Hart(1995)providesanextensivediscussionabouttheimportanceofcorporategovernanceintheabsenceof

    completecontracts.Considerablecrosscountryvariationsinthequalityofthecorporategovernancesystemhavebeen

    foundinanumberofstudies,see,e.g.LaPortaetal.(1998;1999and2000a),Roe(1993),FranksandMayer(1995),Barca

    andBecht(2001),andFaccioandLang(2002).

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    1986)4.

    Controllingshareholdersmighthoweverbeguidedbyotherobjectives thanmaximizing

    shareholdervalue.Oftenrelatedtothepersonwhofoundedthefirm,thistypeofowner(s)may

    identifystronglywithit(Mueller,2003).Ensuringsurvivalandgrowthofthefirm,alongwith

    protecting the family name and reputation, might be important objectives. Controlling

    shareholders may also have the possibility to extract other pecuniary and nonpecuniarybenefitsthatarenotsharedbyothershareholders(Williamson,1963,1964,andJensen,1986).

    Empiricalevidencesupports thehypothesis thatsizableprivatebenefitsexist (Nenova,2003,

    andDyckandZingales,2004).Thepossibility toconsumeonthejobcanalsohave theeffect

    thatretainedearningsarepreferabletodividends.5

    Consequently there areboth costs andbenefits associatedwith controlling shareholders

    leadingtoapotentialconflictofinterestwithminorityownersfortwoprincipalreasons.First,

    regulations do not effectively protect the rights of minority shareholders. Second, the

    governancestructureinmanycountriespotentiallymakescontrollingshareholders,whohold

    themajorityof thevotes andoftenhavemanagerial representation, impervious to takeover

    threatsandmonitoring(Gomes,2000).

    Although the predominance of controlling shareholders in many countries has been

    demonstratedintheliterature(LaPortaetal.1999,andFaccioandLang,2002)6,littleresearchhasbeendoneontheidentityofdifferenttypesofcontrollingshareholders.Moreresearchinto

    this area is consequently needed.A recent studybyMaury (2004) investigates how firms

    performanceisaffectedbyfamilycontrolonalargecrosssectionalsampleofEuropeanfirms.

    Inparticular,theeffectoffamilycontrolonperformance,measuredbyTobinsqandreturnon

    assets (ROA), is investigated. The conclusion is that family controlled firms perform

    significantlybetterbothintermsofTobinsqandROAthanfirmscontrolledbyotherowners.

    Controllingshareholders,suchas familyowners, typicallyholdmorecontrol rights than

    cashflowrights.Thistypeofcontrolenhancementcanbeaccomplishedthroughanumberof

    mechanisms, such as votedifferentiated shares, pyramidal control structures, and

    crossholdings7.ExaminingalargepanelofSwedishlistedfirmsBjuggren,EklundandWiberg

    (2007)presentevidence thatmodifythefindingsofMaury(2004).Privatecontrollingowners

    (e.g. families, individualsandevenother firms)areshown tohaveapositivebutmarginallydiminishing effect on investment performance, measured as marginal q. If the control is

    maintained through disproportional voting arrangements however, this positive incentive

    effectdisappears.TheresultsbyBjuggren,EklundandWiberg(2007)alsoindicatethatforeign

    and institutionalownershaveapositiveeffecton investmentperformance.The issue is thus

    not simply amatter of identity; themeansbywhich the control ismaintained is also an

    importantdeterminantofbothownershipandperformance.

    Thenextpartofthepaperismadeupoffivesectionsthatfocusontheresearchrelatingto

    4 Inthiswaycentrallycontrolledbusinessgroupscansubstituteforunderdevelopedeconomicinstitutions(Khanna

    andYafeh,2006).Moreconcentratedcontrolcanalsomotivateentrepreneurialeffort(Allaire,2006).5 Thiseffectmaythenbereinforcedbytaxpolicies,andultimatelyleadtooverinvestment.ForthecaseofSwedenin

    particular,strongtaxincentiveshavefavouredretainedearningsrelativetodividendsasapartofthelongtermsocialdemocraticeconomicprogramuptothe1990s(Hgfeldt,2004,andHenreksonandJakobsson,2001;2005).6 InvestigatingtheevolutionofownershipandcontrolinatransitioncountryGregoricetal.(2000)findsthatthe

    governancestructureofSlovenianfirmsismovinginthedirectionofthecontinentalEuropeangovernancesystem,

    withcontrollingprivateownersandlargeholdingscontrolledbyfinancialinstitutions.7Arecenttheoreticaloverviewconcerningcontrolenhancingmechanismsandtheoneshare onevotestructureis

    BurkartandLee(2008),fortheempiricalevidence,seeAdamsandFerreira(2008),Rydqvist(1992),andAllaire(2006).

    Forpyramids,seeBebchucketal.(2000)andforcrossholdingswithinbusinessgroups,seeKhannaandYafeh(2006).

    TheoptimalallocationofcontrolandcashflowrightsinafirmisanalyzedbyGrossmanandHart(1988)andHarris

    andRaviv(1988)

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    investment andperformance indifferent corporate governance contexts.The first section is

    namedIndustrySpecificEffectsandPerformanceofFirms.Itprovidesanoverviewoftheresearch

    investigatinghowtheperformanceoflistedfirmschangeinresponsetomarketsentimentsand

    specificindustryattributes.Themainconclusionisthatmarketvaluationdiffersbetweenfirms

    operating in new and old industries as a result of information asymmetries. Performance

    measures based on market valuation must consequently control for these firm andindustryspecificeffects.

    Thefollowingtwosectionsofparttwofocusontheroleofinstitutionalownersasmonitors

    in the relation between controlling shareholders and minority owners. Section two titled

    Institutional Ownership and Performance examines the empirical evidence available which

    concernstheeffectofinstitutionalownershiponinvestmentperformance.Theevidenceseem

    toindicatethatinstitutionalownersinfluenceinvestmentperformancepositively.Furthermore,

    controlinstrumentssuchasdualclassshares,areshowntoreducetheinvestmentperformance

    of firms.Section three, InstitutionalOwnershipandDividends, review thestudies investigating

    how institutional ownership affects firms dividend policy. By demanding higher dividend

    payoutratiosinstitutionalownersmayreducethecashavailableformanagerialdiscretionand

    thus alleviate the conflict between inside and outside shareholders. The effect of control

    enhancingmechanismsseemtobeofparticularimportance.Controlenhancingmechanismsisa corporate governance attribute much spread in continental Europe, yet little empirical

    evidenceexistsregardingtheeffectsofthistypeofinstruments.

    Thefourthsectionlooksattheresearchthathaveinvestigatedwhetherabovenormprofits

    existdespitetheassumptionofcompetitivemarkets.ThenameofthesectionisPerformanceand

    PersistenceofProfits.TheempiricalinvestigationsdealingwiththeeffectofR&Dinvestmentsin

    relation toprofitpersistence is reviewed.The evidence seem to support the idea thatabove

    normprofitsaretheresultofamongstotherthingspersistentinvestmentinR&D.

    Narrowingthefocusonperformancetomutualfunds,ThefifthsectiontitledRiskAdjusted

    PerformanceMeasures, examines some evaluation techniques used in comparisons ofmutual

    fundsagainstbenchmarks.Theliteraturesuggeststhatmutualfundsonaverageunderperform

    theirbenchmarkindices.Thisunderperformanceisoftenarguedtobeaconsequenceofalower

    levelofriskinthemutualfundstheninthebenchmark.TheusefulnessoftheModiglianiandModiglianimeasurerelativetoothermoreesotericperformancemeasuresisalsodemonstrated.

    Part three of the paper deals with somemethodical issues common to empirical studies

    investigatingtherelationshipbetweencorporategovernanceandperformance.Partfourends

    thepaperwithasomesummarizingconclusions.

    2. RESEARCHONOWNERSHIP,GOVERNANCEANDPERFORMANCE

    This following sectionspresentabrief theoreticalandempirical framework foreach fieldof

    researchbyreviewingsomeimportantpapersoneachtopic.Thereviewofpapersshouldnot

    beseenascomprehensive,butratherasanintroductiontotheproblemscurrentlydiscussedin

    thedifferentresearchfields.

    2.1 IndustrySpecificEffectsandPerformance

    A largebody of literature has investigated the relationshipbetween corporate governance

    structures andperformance indicators.Although the studiesdiffer greatlyboth in terms of

    estimationtechniquesandsamples,mostofthemhaveincommontheuseofTobinsaverageq

    as performance measure. Tobins q is usually approximated by the markettobook ratio.

    Although Tobins q is commonly used its empirical construction is subject to considerable

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    recessions,because ofbiased estimates of future cash flows. It is not the efficient use of

    resourcessolelythatdeterminesthevalueofthemarginalq,uncertaintyaboutthefirmsfuture

    profitabilityalso affect thevalueof the firms.Any empirical investigationbasedonmarket

    valuation must therefore control for industryspecific sentiments and time related

    macroeffectsthataffectallfirmsinthemarket.

    2.2 InstitutionalOwnershipandPerformance

    The increasing ownership controlled by institutional 12 investors is the major ongoing

    transformation of the capitalmarkets around theworld. Since the early 1990s assetsunder

    management of institutions have tripled and these professional managers now manage

    financialassetsexceeding$U.S.45trillion(includingover$U.S.trillioninequities).Despitethe

    increasing roleof institutionalowners, little isknown empiricallyonhow they affect firms

    performance.

    Ithasbeensuggestedthatinstitutionalownerscanactasmonitorsofmanagers(Demsetz,

    1983andShleiferandVishny,1986).Theargumentisthatinstitutionalownerstypicallyhave

    largeholdings,anditthereforepaysthemtodevelopexpertiseinmanaginginvestments.With

    substantial resources at hand, professional portfoliomanagers canbe assumed tobemoresophisticatedthantheaverageretailinvestor.Theactualinvolvementofinstitutionalinvestors

    inthefirmsoperationsrangefromthethreatofsellingshares(exit)totheactiveuseofvoting

    rights (voice) inshareholdersmeetings.Foramoreextensivesurveyofshareholderactivism,

    seeGillianandStarks(2000).Bymonitoringthemanagementfirmsareforcedtooperateina

    way that ismore consistentwithmaximising shareholderwealth (Agrawal andMandelker,

    1992,Firth,1995).Thesameargumentsalsoapply to theroleof institutional investors in the

    potentialconflictbetweencontrollingownersandoutsideminorityowners(GillianandStarks,

    2003).Investigatingacomprehensivedatasetofequityholdingsfrom27countries,Ferreiraand

    Matos (2008), show that institutional investorsare involved inmonitoring firmsworldwide.

    The results further show that firms with high ownership by foreign and independent

    institutions have higher firm valuation, better operating performance, and lower capital

    expenditure. Institutional investors also seem toprefer stock of large firms and firmswithstronggovernance indicators.Thisviewof institutional investors canbe labelled the active

    investorshypothesis.13

    Onedrawbackofmanystudiesoftherelationshipbetweenownershipandperformanceis

    thattheyuseTobinsaverageqasameasureofperformance.Whatisneededisameasureof

    marginalinvestmentreturnsrelativetothefirmscostofcapital.UsingmarginalqMuellerand

    Reardon (1993) show that a substantial part of the large publicly traded firms in theU.S

    underperform,intermsofhavingmarginalreturnsoninvestmentsignificantlybelowtheircost

    ofcapital.Anemergingbodyofliteraturehassinceestablishedtheusefulnessofthismeasure,

    aswellasprovidednewempiricalevidencerelatedtocorporategovernanceandperformance

    (seeGuglerandYurtoglu,2003,andGugleretal.2004a;2004b).

    12

    Institutionalinvestorscanbedefinedasspecializedfinancialinstitutionsthatmanagesavingscollectivelyonbehalfofsmallinvestorstowardsaspecificobjectiveintermsofacceptablerisk,returnmaximization,andmaturityofclaims

    (DavisandSteil,2001).Inthispaperinstitutionalinvestorsisdefinedinthewidestsenseincluding;banks,mutual and

    pensionfunds,foundations,closedendinvestmentfunds,insurancecompanies,andotherfinancialinstitutionsthat

    manageportfoliosonbehalfofsomecollectivegroupofinvestors.13

    Empiricalsupportinfavourofacertainlevelofactivismbyinstitutionalinvestorshasbeenpresentedinseveral

    studies;see,forexample,Brickleyetal.(1988)andAlmazanetal.(2005).Anecdotalevidencesuggeststhatinstitutional

    investorscolludeduringcertaincircumstancesandregardingparticularissues.Towhatextentthishappensandthe

    importancethereofisanissueofgreatinterestforfutureresearch.Hereitissufficedtoassumethatinstitutional

    investors,althoughoftenveryinfluentialperse,canformshareholderalliancesandcolludewhennecessary.

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    A large fractionof theworldspublicly traded firmsare controlledby their foundersor

    membersofthefoundersfamilies(LaPortaetal.1999;Classensetal.2000;FaccioandLang,

    2002;AnderssonandReeb,2003;Morcketal.2000).Suchownersoftenhaveasubstantialpart

    oftheirpersonalwealthtiedupinthefirms,andarethussupposedtohavestrongcashflow

    incentives to monitor the firm (Jensen and Meckling, 1976). Regarded as insiders the

    controlling owners can also be assumed to be better informed about the firms businessactivitiesthanminorityshareholders.

    Buttherearealsopotentialcostsassociatedwithcontrollingowners.Firstofall,controlling

    owners may extract private benefits of control, benefits that are not shared with other

    shareholders14 (Thomsen et al. (2006) find a negative association between blockholder

    ownership,firmvalue,andaccountingreturns.Itisinterpretedasanindicationoftheconflicts

    of interest between controlling owners and minority shareholders). Secondly, controlling

    ownersmayretaincontrolevenwhentheyarenolongercompetenttorunthefirm(Burkhart

    etal.2003,ShleiferandVishny,1997).Thirdly,controllingownersfrequentlyownmorecontrol

    rightsthancashflowrights.Thisisaccomplishedthroughtheuseofdifferenttypesofcontrol

    enhancing mechanisms, such as dualclass shares, pyramidal ownership structures, and

    crossholdings.Thesemechanismseffectivelyentrenchthecontrollingownersagainstpressure

    from corporate governance mechanisms, such as the market for corporate control ormonitoringbynoncontrollingshareholders(CronqvistandNilsson,2003).Withrelevancefor

    continental European firms CrespCladera and Gispert (2002) show that the agency

    predictionsassociatedwith themarket for corporate control cannotbe fully supported in a

    sampleofSpanishfirms.

    A related issue is thuswhether thewidespread use of control enhancingmechanisms

    distortstheallocationofcapital(Morcketal.2005andKhannaandYafeh,2006)15.Lookingat

    data from Swedish mergers Holmn et al. (2007), find little evidence of shareholder

    expropriation.Extralegalinstitutions,suchastaxcomplianceandmediacoverage,areclaimed

    toworkas informal institutionsconsistentwithgreatershareholderprotection.Applying the

    marginal qmethodologyon Swedishdata,Bjuggren et al (2007)however,provide evidence

    thatdualclasssharesworsen investmentperformance.Furthermore,controllingshareholders

    may favour retained earnings to dividendswhich can lead to overinvestment. The resultsshowthat,onaverage,theSwedishlistedfirmshasmarginalinvestmentreturnssignificantly

    below their costs of capital. These results are confirmed by Eklund (2008) in a study of

    investmentperformanceofScandinavianfirms.

    A influentialpaperonthe impactof institutionalownershiponmarketvalueofequityis

    Claessensetal(2002).Theyinvestigatealargecrosscountrysampleof1,301firmsinEastAsia

    in1996.Regressingmarkettobookvaluesagainstanumberoffirmspecificvariablestheyfind

    thatownershipconcentrationispositivelyrelatedtomarkettobook,interpretedasevidenceof

    thesocalledincentiveeffect.Theyalsofindthatawedgebetweenvoteandcashflowrightsis

    negativelyrelatedtomarketvalue,whichsupportstheentrenchmenthypothesisrelatedtothe

    separationofvotesfromcapital.LaPortaetal.(2002)examineasampleofmorethan500large

    firms in27countries; they find thatTobinsq ispositivelyrelatedtocountrywide indicesof

    investor protection. The differencebetween control and cash flow rights of the controllingshareholderisfoundtohavenosignificantrelationshipwithTobinsq.

    Investigating the effectofmanagerialownershiponTobinsq,KalchevaandLins (2008)

    findnoevidencethatmanagerialcashflowrightsaffectTobinsq.Disproportionalownership

    14 InarelatedstudyCronqvistetal.(2008)provideevidenceinsupportoftheideathatentrenchedCEOspayhigher

    wagestoemployeesastomaintainandenjoynonpecuniarybenefitsofcontrol.15

    SeeEklundandDesai(2008),foradditionalempiricalinvestigationconcerningtheefficiencyofcapitalallocation.

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    however,isfoundtohaveasignificantandnegativeeffectonTobinsq.AstudybyCronqvist

    andNilsson(2003)analyzetheimpactofcontrollingshareholdersvotingrightsonTobinsq,

    for a panel of Swedish firmsduring 19911997.The results are generally supportive of the

    results inClassens et al. (2002),with anegative effect of controlling shareholders voteson

    Tobins q.However, thewedgebetween votes and cash flow rights comes out statistically

    insignificant.Studyingapanelof136Finnishfirmsduring19932000,MauryandPajuste(2004)findanegativeeffectoftheratioofvotingrightstocashflowrightsonTobinsq.

    2.3 InstitutionalOwnersandDividends

    In aworld without taxes, transaction costs, andmarket imperfections, dividend policy is

    irrelevantforshareholderwealth(MillerandModigliani,1961).Assumingthatthisdescription

    oftheworldistoosimplified,agencymodelsofdividendstrytoexplainhowagencyproblems

    affectdividendpolicy.TheargumentaccordingtoLaPortaetal.(2000b,p.4)isthat:

    Inaworldwithsignificantagencyproblemsbetweencorporateinsidersandoutsiders,dividends

    canplayausefulrole.Bypayingdividends,insidersreturncorporateearningstoinvestorsand

    hencearenolongercapableofusingtheseearningstobenefitthemselves.

    The fundamental ideabehind this approach is that the firms investment policy cannotbe

    assumedtobeindependentofitsdividendpolicyinthepresenceofmarketfrictions.Dividend

    payoutsmayinfactevenreducetheinefficiencyofmarginalinvestments.

    Theroleofdividendsinanagencycontextcanbeclassifiedaccordingtotwomainviews

    (LaPortaetal.2000b).Thefirsttypeofagencymodelsregardsdividendspolicyasanoutcome

    ofagencyproblemsandthelegalprotectionofshareholders.Thesecondtyperegardsdividend

    policy as a substitute for legal protection of shareholders. La Porta et al. (2000b) find, in

    supportofthe outcomemodelofdividend, that firmsoperating incountrieswithrelatively

    lowshareholderprotectionpayoutlowerdividendsthanfirms intheUKandtheUS,where

    shareholderprotectionisconsideredtobehigher.ForEuropeanfirmsFaccioetal.(2001)show

    thatthepresenceofanotherlargeshareholdermitigatesagencyconflicts.Thatdividendpayoutdecreaseswith thevotingpowerofthe largestshareholder isshownonasampleofGerman

    listedfirmsbyGuglerandYurtoglu(2003).Conversely,thevotingpowerofthesecondlargest

    shareholderisfoundtohaveapositiveeffectondividendpayouts.

    Basedontheassumptionthat institutionalinvestorsaremorelikelytoinvestindividend

    paying stocks (justifiedbyprudence restrictions etc.),Allen et al. (2000)provide theoretical

    arguments forwhy firms pay dividends rather than repurchase shares. Furthermore, they

    argue that institutionalowners,with largeownership stakes,playamore important role in

    overseeingthemanagementthandispersedretailinvestors.

    In linewith an extensivebody of research concerning shareholder clientelesbased on

    taxedinduced preferences for dividends16, PerezGonzales (2003) finds that changes in tax

    ratesaffect firmdividendpolicy in firmswithdominant shareholders.Holmnetal. (2008),

    showanegative

    cross

    sectional

    relationship

    between

    insiders

    effective

    tax

    rates

    and

    dividend

    payout.Lookingalsoat the impactof largeblock tradesondividends, theyshow that large

    shareholders adjust dividends to suit their individual tax situations.Dahlquist et al. (2007)

    16 ThepathbreakingworksinthisbodyofresearcharethestudiesbyMiller(1977),MillerandScholes(1978)and

    BrennanandThakor(1990)whoexaminetheeffectoftaxesonaninsidershareholderspreferencesforcapitalgainsor

    dividends.Theempiricalevidencehasshownthat,ceterisparibus,thehigherthetaxratepaidondividends,thelower

    thepreferreddividendpayout.

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    show that taxneutral investors, such as institutional investors17, have significantly higher

    dividend yields on their portfolios than investors facedwith higher effective tax rates on

    dividendsthanoncapital.FromasampleofFinnishfirms,Kinkki(2008)suppliesevidencethat,

    in cases where the controlling shareholders do not have absolute control, minority

    shareholderscolludetoaffectdividendpolicy.Regardinginstitutionalownershipinparticular,

    Del Guerico (1996) and Grinstein and Michaely (2005) find that institutions preferdividendpaying stocks. In linewith these resultsMichaely etal. (1995) andDhaliwal etal.

    (1999) document changes in institutional ownership around dividend initiations and

    omissions.

    Bypayingoutdividendsthefirmwillalsobemoredependentonthecapitalmarket.The

    capitalmarketwillthussupplymonitoringatalowcostforoutsideshareholders(Easterbrook,

    1984).Inthisway,thesubstitutemodelsofdividendsrelyontheneedforfirmstoraisenew

    capitalthroughthecapitalmarket.Todosoonattractiveterms,thecontrollingshareholderor

    managermustestablishareputationfornotexpropriatingoutsideshareholders(Maury,2004).

    Ina relatedpaper,Myers (2000)proposes thatmanagers can stay in control,only ifoutside

    shareholdersbelievethatfuturedividendpaymentswillbemade.In linewiththisreasoning

    Gomes (2000) suggests that managers or controlling shareholders could reduce agency

    problems,bydevelopinga reputation for treatingoutside shareholderswell.Zwiebel (1996)argues thatmanagers pay dividends in order to avert challenges for control. The treat of

    takeover is consequently disciplining managers and mitigating inefficient use of retained

    earnings.Thispropositionwouldalsoexplainwhymanagersseemreluctanttolowerdividend

    payoutratiosinresponsetodecliningprofits.18LookingatthepayoutratiooftheU.S.equity

    marketportfolio,ArnottandAsness(2003) findthatearningsgrowth is largestwhencurrent

    payoutratiosarehighandsmallestwhenpayoutratiosarelow.Thisevidenceis in linewith

    theview thatmanagersusedividends tosignal futureearningsexpectations,orengaging,at

    times,ininefficientempirebuilding.

    2.4 PerformanceandthePersistenceofProfits

    Tantamount toperformanceakeyvariable in economicanalysis isprofitability,notonlyasevidence of a firms productivity,but also as a foundation of the economic accumulation

    process.Sinceprofits,formostfirms,aregeneratedinaprocessofcompetition,studiesabout

    thedynamicsofcompanyprofitsoftenstartoutbyanalyzingtheprocessofcompetition.This

    branchofresearchwas initiatedbyMueller (1977,1986)ConnollyandSchwartz (1985),Levy

    (1987),GeroskiandJacuemin(1988).Thequestionoftheintertemporalpatternofprofitability

    relatedtomarketstructurehadpreviouslybeenraisedbyBrozen (1971a,b).Foranexcellent

    review ofprevious studies, see The dynamics of companyprofits: an international comparison

    (Mueller,1990).Underlining these studies is theassumption thatmonopolisticattributesare

    present inmany firmsand industries,evenundercompetition.Asa resultprofitsabove the

    normcanbefoundinsomefirmsandindustries.Mueller(1986,p.27)concludesthat:

    Althoughthegeneralpatternofresultsisconsistentwithanoverridingtendencyforprofitstoregressbackontosomenormal,competitivelevel,theregressionisnotcompleteeitherinthe

    sensethatallfirmsexhibitsucharegression,orthatthosethatdoexperienceacompletereturnto

    thecompetitivelevel.

    17 BasedontheclassificationofinvestorsaccordingtotaxpreferencesDahlquistetal.(2007)alsoinvestigateSwedish

    investmentfunds,whichisidenticaltoclosedendinvestmentsfunds.Thisgroupofinvestors,oftenpivotalascontrol

    instrumentsinthetypicalSwedishownershipspheres,isfoundtohavepreferencesforretainedearnings.18

    Fordiscussion,seeShortetal.(2002).

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    In particular, it has been shown that undermonopolistic competition abovenorm profits

    persistasaresultofmarketpoweror in the formofnewproductsor technologies(Mueller,

    1990).Bourlakis(1997)testthecompetitiveenvironmentandpersistenceofprofitshypothesis

    forasampleofGreekmanufacturingfirmsbetweentheyears1958to1984.Theresultsshow

    that high industry concentration and highbarriers to entry lead to new firms entering the

    market,which indicate thatdisciplinarycompetitive forcesareatwork in themanufacturingindustries.

    Asframeworkfortheanalysisofthecompetitionprocesstwobasicmodelshavebeenused

    in the literature. Within the first framework, concentration and profitability are directly

    correlatedand thedivergencebetweenprice and costs isgreater in concentrated industries.

    Mostempiricalworkbasedon thismodel iscrosssectional innaturewithavectoroffactors

    determining the levelofprofitability.Themajordrawback in this typeof analysis is that it

    takeslittleornoaccountofdynamicprocesses.Theseprocesses,i.e.entryandexitsoffirmsin

    responsetoabnormalprofitswithinindustries,maynaturallyerodeprofitsandrenderpolicy

    implications void. The other type of framework is based on a perspective of creative

    destruction.Accordingtothisviewinnovationcreatesmonopolies;monopoliescreateprofits,

    and this subsequently generates imitators until normal returns are restored within the

    industry19.Roberts(2001)presentsatheoreticalframeworkforfirmlevelprofitpersistencethatembracesproductandcompetitorinnovation,and,moreimportantly,theprospectthatseveral

    productinnovationsmaybematerializedwithinasinglefirm.

    Theusual factorsused todescribe thedeterminantsof long runprofitabilityare;market

    structure (industry characteristics),market share, market share growth, productivity, firm

    concentration ratio, replacement value of capital stock, and growth of the firm.Other, less

    straightforwarddeterminantsarebarrierstoentry,minimumefficientsizemeasures,stockof

    advertising,and the stockof researchanddevelopment (R&D).RobertsandDowling (2002)

    find that firmswitha relativelygood reputationarebetterable to sustainprofitsabove the

    norm.RegardingR&D,itislikelythatitisthepersistenceinR&Dinvestmentsratherthanthe

    absolutestockthatinfluencethelongrunprofitability.

    InastudyoffirmlevelprofitabilityYurtoglu(2004)show,usingasampleofthe172largest

    multinationalfirmsinTurkey,thatfirmlevelprofitsconvergebutthattheconvergenceprocessisincomplete.DuetounavailabilityofdatanotestsaremaderegardingtheeffectofR&Don

    profitability.Studyingindustryaggregatesforasampleofmorethan12,000USfirmsWaring

    (1996)however, findsthat industryspecificitiessuchasR&D levelshaveasignificant impact

    on thespeedofconvergence.Bentzenetal. (2005)confirm theresult that industryaggregate

    returnspersist,inastudyofDanishfirmsandprofitability.Inastudybasedonalargepanelof

    nearly1600DanishfirmsSmithetal.(2003)investigatehowownershipaffectthepersistenceof

    firmprofits.The results indicateapositive relationshipbetween thenumberofowners, the

    persistenceofprofits,andthepermanentleveloffirmprofits.Conversely,firmscharacterized

    byahighlyconcentratedownershiparefoundtohavesignificantlyhigherrents.Althoughnot

    discusseddirectlyinthestudy,theseresultsmightbeanindicationofanonlinearrelationship

    betweenownershipandperformance(Morck,Shleifer,andVishny,1988).

    InvestigatingJapanesemanufacturing firms,OdagiriandYamawaki (1990)alsoconcludethatprofitspersist. In a recent study using fifteen years of additional dataMaruyama and

    Odagiri (2002) show that this persistence of profits persist. Furthermore, the firms profit

    performanceisshowntobepositivelyrelatedtomeasuresofmarketshare.

    19 SeeKlepperandGraddy(1990)foraseminalstudyofthesocalledproductlifecycle.

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    2.5 RiskAdjustedPerformanceMeasures

    Consumerswould like themutual funds they invest in tomaximize riskadjusted expected

    returns.Portfoliomanagers,however,areoftenmotivatedbytheircompensation,whichistied

    to themutualfundcompaniesassetsundermanagement.Iftheactionsthatmaximizeassets

    under

    management

    differ

    from

    the

    actions

    that

    maximize

    risk

    adjusted

    expected

    returns,

    inefficienciesrelatedtothisconflictwillarise.AseminalpaperinthisareaisLakonishoketal.

    (1991)WindowDressingbyPensionFundManagers;seealsoChevalierandEllison(1997).One

    can therefore characterize the relationshipbetween retail investors,portfoliomanagers, and

    mutualfundcompaniesasadoubleprincipleagencyproblem.20

    Many researchers have questioned the rationality of investorswho placemoneywith

    active managers, despite their apparent inability to outperform passive strategies21. The

    relativeperformanceofmutual fundmanagers also seems tobe largelyunpredictable from

    past relative performance (Berk andGreen, 2004).Many researchers have regarded this as

    evidenceformarketefficiency(seee.g.Malkiel1995,andRoss,WesterfieldandJaffe2002). 22

    This withstanding, considerable effort and resources are devoted to evaluating past

    performanceofmanagers (Gruber1996, andDaniel etal.1997).The reason is thata strong

    relationship

    has

    been

    documented

    between

    the

    inflow

    of

    new

    investment

    into

    a

    mutual

    fund

    and the funds past performance (Patel et al.1990, Ippolito, 1992, Sirri and Tufano, 1998,

    Agrawaletal.2004,andBaqueroetal.2005).Sinceportfoliomanagersusuallyreceiveafixed

    percentageofassetsundermanagementascompensation,theywillhavean incentivetotake

    actionsthatincreasethetotalassetsofthefund.

    Practitioners inthefinancial industryoftenputstrongemphasisonevaluationsbasedon

    totalreturn,althoughmoresophisticatedmeasuresexist.Academicsontheotherhand,often

    stress individualutility functionsandmeasuresofportfolioperformancebasedon socalled

    prospect theory,which capturesnotonly riskand return,butalso reflectsdifferences in the

    aversiontoupsideordownsiderisk(Gemmilletal.2005).Themostconventionalriskadjusted

    performancemeasuresusedbybothpractitionersandacademicsare;theSharperatio;Jensens

    alpha; theSortino ratio (SortinoandVanderMeer,1991);and theHigherMomentmeasure

    (HwangandSatchell,1998), for reviewsofperformancemeasuresseeChenandKnez (1996)

    andAmencandLeSourd(2007).Returnbasedstyleanalysis,amethodintroducedbySharpe

    (1988,1992)hasalsobecomeapopular toolwhenevaluatingmutual fundreturns (Formore

    detaileddiscussion see,VanCampenhout,2002).The techniquesandmethodsofevaluating

    therelativeperformanceofmutualfundmanagersarethusamanyastheyarediverse.

    There ishowevera consensus thatagoodperformancemeasure forportfolioevaluation

    shouldreflectnotonlythereturn,butalsotherisktakentoachievethatreturn,relativetosome

    20Consideringalsothatthemutualfundcompanyhascontrollingownersonecoulddescribeitasathreefolded

    agencyproblem;foranexcellentreviewrelevanttotheSwedishmutualfundindustryinparticular,seePlsson(2001).

    Forageneraldiscussionaboutmutualfunds,seeHaslem(2003).21AleadingpaperwithinthisfieldisJensen(1968),seealsoCarhart(1997)foranextendeddiscussionasregardsto

    thepersistenceinmutualfundreturns.

    22 Theefficientmarkethypothesisstatesthatsecuritypricesfullyreflectallavailableinformation,assumingnocosts

    associatedwithinformationortrading(GrossmanandStiglitz,1980).Inrealityhowever,therearesurelypositive

    informationandtradingcosts(Fama,1961;1991).RecognizingthisJensen(1978)reformulatetheefficiencyhypothesis

    assayingthatsecuritypricesreflectallinformationtothepointwherethemarginalbenefitsofactingoninformation

    donotexceedthemarginalcost.Ambiguityregardinginformationandtradingcostsisnot,however,themain

    impedimenttoinferenceaboutmarketefficiency.Thejointhypothesisproblem,oftestingthehypothesistogetherwith

    someassetpricingmodel,maybemoreserious(Fama,1991).Althoughtheremightbedisagreementaboutthe

    implicationsforefficiency,mostacademicsagreeonthefactsthatemergefromtestunderlinedbytheassumptionof

    marketefficiency.Theempiricalworkonmarketefficiencyandassetpricingmodelshasfundamentallychangedthe

    viewsandpracticesofmarketprofessionals(Fama,1991).

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    appropriate benchmark 23 . An important issue relevant for most measures of portfolio

    performanceis,thattheevaluationmethodshouldbeeasytounderstandanduse.Withoutthis

    featuremanyevaluationtechniquesandperformancemeasuresremainacademiccomments.

    Modigliani andModigliani (1997) thereforepresent ameasureofportfolioperformance

    which through a theoretical leveraging of the portfolio makes it riskequivalent to the

    benchmark index. Themeasure, referred to as theM2measure (from the two authors), isessentiallyanadaptationof theSharperatio (Sharpe,1966).The twomeasures consequently

    rankportfolios identically.Compared to theSharpemeasure,which remains ratheresoteric,

    themeritof theM2measure is that itcalculates theriskadjustedperformance inpercentage

    points,liketheoriginalreturnofanyportfolioorbenchmark.

    Common to all performancemeasuresbased on variance as ameasure of risk, is the

    assumption of normality inNetAsset Value (NAV) returns.MostNAV returns however,

    demonstrateskewnessandkurtosis(Gemmilletal.2005).Acontinuingandwidespreaduseof

    varianceasmeasureofriskneverthelessspeaks in favorof thisassumptionwhenevaluating

    portfolioperformance.

    InarecentstudyKosowskietal. (2007) investigatewhether it ispossible todetect funds

    thatoutperformthemarketbydroppingtheassumptionofnormalityassociatedwithclassict

    tests.Usingboot strappederrors they find that somemanagersareable toproducepositivealphas. Ifsuchskillsexist,theywillmostlikelydisappearassoonastheyarediscoveredas

    investorswouldbuyintothoseparticularmanagersfunds.ThiswouldthensupportBerkand

    Greens (2004) hypothesis about fund returns in a competitive environment.Over the last

    decade there have been many more attempts to analyze returns from portfolios with

    asymmetries in investmentreturns (foroverview,seeKeatingandShadwick,2002).Thishas

    resulted in the current fashion for style analysis (i.e.,Lhabitant, 2002;Chan et al. 2002). In

    particular,much of thework hasbeen devoted to hedge funds (Sirri and Tufano, 1998;

    Agrawaletal.2004,andBaqueroetal.2005).

    Part three of the review now follow with a discussion of some methodological and

    empirical issues thatarerelevant forall these fieldsof research.Ashortcommentaryon the

    differencesbetweenTobinsaverageqandMarginalqisincluded.

    3. METHODOLOGICALANDEMPIRICALISSUES

    Most studies in the corporate governance literature normally use some proxy for the

    performance of the firm as dependent variable. Usual performance measures are net

    income/networth,returnonequity,andreturnonassetsorTobinsaverageq24.Furthermore,

    themajorityofstudiesexploredataofeitherUSorUKlargefirms(foroverview,seeGugler,

    2001).Basedonthesedatasetstheassumptionofoneshareonevoteprevailsandlittleregard

    is paid to the difference between cash flow ownership and voting rights. The implicit

    assumption isconsequentlythattheeffectofaseparationofvotesfromcapital is immaterial.

    Othermethodological issuesrelevantfor investigationsconcerningcorporategovernanceand

    performanceare;omittedvariables,firmandindustryeffects,andreversecausality.Although

    more research isgenerallywarranted, some studieshave tried toaddress these issuesmoreindepth.Thissectionwilltrytosummarizesomeofthefindings.

    23 Foradiscussionaboutmeasuresofmutualfundperformanceandbenchmarks,seeLehmannandModest(1987).24AnalternativeapproachistoapplythesocalledEulerequationmodel(BondandMeghir,1990),whichbasically

    considersoptimalcapitalaccumulationinthepresenceofconvexadjustmentcosts.UsingthismethodologyRondiet

    al.(1994)findthat,consistentwiththeliteratureontheeffectoffinancialfactorsoncompanybehaviour,ownershipis

    relatedtothesensitivityofcashflows.Stateownedfirmsarefoundtobemoresensitivetocashflowthanprivately

    ownedfirms.Theresultsalsosuggestthatfirmsizeisrelevantfortheavailabilityofexternalcapital.

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    3.1 TobinsqversusMarginalq

    Although correct for estimating a firms expected future growth opportunities the usual

    Tobinsq,marketvalueofequityanddebtoverthereplacementcostofcapital,actuallysays

    verylittleaboutthepastperformanceofthefirmsinvestments.Aperformancemeasureused

    in

    empirical

    investigations

    concerning

    corporate

    governance

    and

    firms

    performance

    should

    mirrorhowwellthemanagementsucceedsinmaximisingshareholdervalue.AlthoughTobins

    q has thisproperty theoretically, its true application in empirical studies fails to provide a

    properevaluation.InfactTobinsqisanaveragemeasureofperformanceandassuchitsuffers

    fromsomeseriousdrawbacks25.Apartfromconfusinginframarginalandmarginalreturns,the

    useofaveragemeasuresofperformanceimplytheneedtospecifyafullystructuralmodelof

    the determinants of performance (Gugler and Yurtoglu, 2003). The problems of omitted

    variable, reverse causality, and /or endogeneity typically follow. An analysis of efficient

    resource allocation thereforehas tobe of amarginal character (Mueller, 2003).Mueller and

    Reardon(1993)deriveamarginalq,whichisessentiallythemarginalTobinsq.Assumingthat

    the market is efficient, the problems associated with average returns and calculating

    firmspecificcostofcapitalcanbecircumvented.

    The

    marginalqmeasures

    the

    ratio

    of

    the

    change

    in

    a

    firms

    market

    value

    to

    the

    cost

    of

    the

    change in totalassets (investment) that caused it.Themarket efficiency assumption implies

    thatthemarketmakesanunbiasedestimationofthefirmsfuturecashflows.Amarginalqless

    (greater)thanone,indicatesthattheinvestmentsatthemarginhadareturnless(greater)than

    thecostofcapital.Firmvalue is thusonlymaximizedwhenmarginalq isequal toone.The

    marginalqalsoallowsfordifferentlevelsoffirmspecificrisk(firmspecificcostofcapital)by

    presupposingacorrectmarketevaluationofthefirmsinvestmentsandvalue.

    Another advantagewith themarginal q is that it obviates the need to specify a fully

    structuralmodel of the determinants of performance. A sufficient condition of inefficient

    investmentdecisionsisthatmarginalqisbelowone(GuglerandYurtoglu,2003).Problemsof

    reverse causality or endogeneity are also not likelywhenmarginal returns are examined.

    GuglerandYurtoglu(2003,p.380)presentanexample:

    lowaverageTobinsqforfirmswithadiffuseownershipstructuremightnotindicatethatthe

    shareholdersarepoormonitorsofmanagers,butratherthatoriginallargeshareholdershave

    diffusedtheirholdingsbecauseinvestmentopportunitieswereboundtodeclineorsimplybecause

    theywantedtodiversifytheirwealth.Anestimatedqmoflessthanone,ontheotherhand,mustbe

    interpretedasamanagementfailure.Iffirminvestmentopportunitiesarelow,andits

    managementaremaximizingshareholderwealth,theywillinvestlittleandthereturnsonthis

    investmentwill(atleast)equalthecostofcapital.

    Marginal q thushas a straightforward interpretation,with amarginal returnon investment

    belowthecostofcapitaltheshareholderswouldhavebeenbetteroffifthefirmhaddistributed

    thesefundsdirectlytotheminstead.Conversely,marginalreturnsoninvestmentgreaterthan

    thecostofcapitalimplyinsufficientinvestment,orcashconstraintsfacingthefirms.

    3.2 MeasurementandEstimationProblems

    Aproblemwhenstudyingtheinfluenceofownershiponfirmperformanceisthatperformance

    mayalso influenceownership, that is, the relationship is endogenous. Itmay as a resultbe

    25 PerfectandWiles(1994)comparefivealternativeestimatorsofaverageq.TheirresultsindicatethatTobinsq,

    amongstotherthings,ishighlysensitivetotheestimationmethod.

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    difficult to identify the trueeffectofownership.Thisproblem isalso referred toas reversed

    causalityandithasanumberofimportantconsequencesfortheinterpretationoftheempirical

    results. In the previous section it was explained why this problem is unlikely when the

    marginalreturnoninvestmentisexamined.

    Anotherindicationofthedirectionofcausalitybetweencorporategovernancefactorsand

    performancecanbethefunctionalformoftherelationship.Morcketal.(1988)investigatetherelationshipbetweenmanagementownershipandthevaluationoffirms,measuredbyTobins

    averageq.They find that this relationship isnonmonotonic,meaning thatTobinsaverageq

    firstincreases,thenfall,andfinallyrisesagainasmanagementownershiprise.Theresultsare

    thus in linewith thesocalledentrenchmenthypothesis.Apositivebutdiminishingeffectof

    ownershiphassincebeenrecordedinanumberofstudies,seeamongstothersMcConnelland

    Servaes(1990),GedajlovicandShapiro(1998),Migueletal.(2004),andPindadoanddelaTorre

    (2006). Any study that attempts to asses the effect of ownership on performance should

    thereforecontrolforthispotentialnonlinearityintherelationship.

    InaseminalpaperbyHimmelbergetal.(1999)apaneldatamethodologyisusedtocontrol

    for both endogeneity and unobserved heterogeneity in the managerial ownership and

    performance relationship. The results are consistent with the predictions of the

    principalagencymodels, and a large fraction of the crosssectional variation inmanagerialownership is found to be explained by unobserved heterogeneity. There are two main

    econometricmotivationsforusingapaneldatamodelling.Thefirstisthedesiretocontrolfor

    unobserved timeinvariant heterogeneity. The second is to study the dynamics of

    crosssectionalpopulations(Arellano,2003).Particularlythepossibilitytocontrolforfirmsor

    industry related heterogeneity has attracted attention within the corporate governance

    literature.

    Reviewing the existing empirical evidence concerning control enhancing mechanism,

    Adams andFerreira (2008)makes inquires for studies, additional toCronqvist andNilsson

    (2003)26,whichusesthefirmfixedeffectsmethodologytocontrolforheterogeneity. Theterm

    fixedeffectsreferstothesamplinginwhichthesameunitsarerepeatedlysampledforagiven

    period holding constant the effects. The researcher can thus control for firm or industry

    heterogeneitynotdirectlyobservable in the sampleof firms.Due tosometimes limited timevariationinboththedependentandtheexplanatoryvariables,analternativeapproachtopanel

    datamodelsistousecrosssectiondataforeachyearseparately27.

    While ownership may differ significantly across firms Zhou (2001) shows that these

    changesin(managerial)ownershiptypicallychangesslowlyovertimewithinacompany.By

    relyingonwithinvariationconsequently, fixedeffectsestimatorsmaynotdetectaneffectof

    ownership on performance even if one exists. Other types of owners however, such as

    institutionalowners,most likelyalter theirownership stakesmoreoften. Industryvariation

    may also be substantial, making fixed effects models with industry effects viable as an

    alternativetofirmeffects.

    Assumingthatcontrollingownersmaypreferlowdividendpayments,ifprivatebenefitsof

    control are extracted, and thatminority shareholdersmay prefer high dividends, Thomsen

    (2004)triestodistinguishbetweentheincentiveandentrenchmenteffects.UtilizingaGMM28

    methodology, which accounts for potential endogeneity, a negative effect of blockholder

    26AlthoughAdamsandFerreira(2008)onlymentionCronqvistandNilsson(2003),recentstudiesareincreasingly

    usingpaneldatamethodologiesandfixedeffectsmodelsforestimations,seei.e.Wiberg(2008).27

    GiannettiandSimonov(2006)findlittletimevariationingovernancecharacteristicsofpubliclyheldfirmsin

    Swedenfrom1995to2001.28

    Forindepthdiscussionoftheestimationtheoryofgeneralizedmethodofmoments(GMM)andoptimalinstrumental

    variables,seeArellanoandBond(1988).

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    ownershipon firmvalue (measuredbyTobinsq) is found in continentalEurope.The same

    effectisnotverifiedforfirmsintheUSandUK.Inaddition,blockholderownershipisfoundto

    haveanegativeeffectondividendpayoutratios.InasimilarstudyThomsenetal.(2006),use

    Granger tests to investigate thecausalrelationshipbetweenblockholderownershipand firm

    performance.Againtheresultssupportanegativeassociationbetweenblockholderownership,

    overacertainlevel(>10%),andperformance.BenfratelloandSembenelli(2006)alsostresstheimportanceofcontrolling forsimultaneityofownershipvariables inastudyof theeffectsof

    foreign ownership on productivity.Applying aGMMmethodology on a sample of Italian

    located firms, and controlling for input simultaneity, the results indicate that foreign

    ownershiphasnoeffectonproductivity.However,whenalsocontrollingforsimultaneityof

    ownership, they find thatnationalitymattersandUS firms tend tobemoreproductive than

    firms under Italian ownership. Overall, the results from empirical investigations of

    endogeneity in theownershipandperformance relationshipgivesupport for the findings in

    previous studies.That is, apositivebutdiminishing effectof ownership concentration, and

    aggravatedagencyconflictsbetweencontrollingshareholdersandminorityshareholders,due

    toincentiveandentrenchmenteffects.

    4. SUMMARYANDCONCLUSIONS

    Basictheoryoffinanceassumesthatinvestmentistheonlyfundamentalfactorexplaining

    longtermchangesinfirmmarketvalues.Existingresearchsuggeststhatinvestmentsrepresent

    a fundamental factor explaininghowmarketvaluesof firms change.During timesofgreat

    marketuncertaintyhowever,suchasinastockpricebubble,investorsseemtobemoreprone

    tomakingsystematicerrorsintheirforecastoffirmsoperatingincertainnovelindustries.As

    these firmsareoperating in industrieswith limitedhistoricaldata, informationasymmetries

    willbemoremalignantthaninindustrieswherealargebodyofpreviousexperienceexists.

    Regarding institutional owners influence on investment performance of firms empirical

    evidence indicate that both domestic and foreign institutional owners influence firm

    performancepositively.Byestimatingfirmperformancewiththemarginalqmethodologyitis

    possible to estimate the firms actual performance in terms of investment efficiency. Theempiricalevidenceisconsistentwithboththeincentiveeffectofincreasingownershipandthe

    socalled entrenchment effect.That is, the relationshipbetween institutional ownership and

    firm performance is found to be positive but marginally diminishing. When control

    instrumentssuchasdualclasssharesareused,thepositiveeffectofinstitutionalownershipis

    absent,most likelydue to increasedagencyproblemsrelatedtotheaugmentedseparationof

    ownershipfromcontrol.Theuseofthistypeofcontrolinstrumentsthusbecomesanimportant

    determinant of firm performance which eradicates the otherwise positive incentive effect

    associatedwithincreasedownership.

    InlinewithLaPortaetal.(2000b)itisarguedthatthepresenceofinfluentialstakeholders,

    other than the controllingowner(s)ormanagement, can influence theperformanceof firms.

    Studies investigating the linkbetween institutionalownershipanddividendpaymentshave

    providedevidence insupportof thisclaim. Inparticular ithasbeenshown that institutionalownersinfluencethefirmstodistributealargerfractionoftheprofitstotheshareholders,thus

    limiting the resources available formanagerial discretion.Most studies on the relationship

    betweenownershipanddividendshavebeenmadeonUSorUKdata,whichdonottakeinto

    consideration the particular governance attributes of the continental European corporate

    governancemodelwithhighlyconcentratedownershipstructurerelatedtocontrolenhancing

    mechanisms.

    Microeconomictheorypredictsthatthedynamicprocessofcompetitionwillrestoreprofits

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    toanormallevel.Accordingtothispointofview,profitsinexcessoftheopportunitycostof

    capitalarenothingmorethanatransitorydisequilibriumphenomenon.Dependingonthefirm

    structureandconcentrationinaparticularindustry,profitswillmovetowardstheequilibrium

    profitleveli.e.theindustryaverage,duringacertainamountoftime,iftheprofitsconvergeat

    all.Somefirmshowever,canmaintainprofitsabovetheindustryaverage,evenintheabsence

    of significantbarriers toentryandexit.By investing inR&D for instance firms candeveloptechnique,goodsandservicesthatallowthemtomaintainacompetitiveedge,andthussustain

    profitsabovetheindustryaverage.

    Anumberofstudieshasinvestigatedthepropositionthatfirmspecificabovenormprofits

    existand that theseprofitspersistover time.Byapplyingdynamicpaneldatamethodology

    whichaccountsforbothtimeandfirmeffectstheroleplayedbyR&Dinvestmentinrelationto

    profitpersistencecanbefurtherexplored.Manypreviousstudieshaveappliedacrosssection

    methodologyalthoughapaneldataapproachallowsamoreaccurateinferenceoftheestimated

    parameters.

    The empirical evidence show that profits converge over time, but this process of

    convergenceisincomplete.Firmsthathadprofitssignificantlyhigher(lower)thantheindustry

    average20yearsago,stillpresentprofitsabove(below)theaverage.Oneexplanationforthis

    persistent profit divergence, and particularly for profits above the norm, is sustainedinvestmentsinR&D.NotonlydofirmswithsustainedR&Dinvestmentsexhibithigherprofit

    levels,therelativelevelofR&Disalsopositivelyrelatedtothepersistenceofthefirmsprofits.

    Thereisnoconsensusintheliteratureonareturnmeasureappropriatefortheevaluation

    of institutional investors and in particular on how to appraisemutual fund performance

    empirically.AmeasuredevelopedbyModiglianiandModigliani(1997)mayneverthelessbea

    goodcandidatetouseasmeasureofriskadjustedperformance.Themainadvantagewiththis

    measure is that itappraisesperformance inbasispoints like theoriginalreturnofanyasset.

    Whenriskadjusted inthisway,empirical investigationsshow that theperformanceofmany

    mutual funds improves noticeably, althoughmost funds still underperform thebenchmark

    index.Thereasonforthisunderperformanceisgenerallyattributedtoalowerrisklevelinthe

    mutualfundportfolioscomparedtothebenchmarkindex.

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Explore The Levels of Creation

Steve Jobs' Commencement Speech at Stanford

Steve Jobs' Commencement Speech at Stanford

How Computer Keyboards Work

How Computer Keyboards Work

I Am a Holocaust Denier and I Am Unafraid

I Am a Holocaust Denier and I Am Unafraid

Heidegger Kritik

Heidegger Kritik

18 Tricks to Teach Your Body

18 Tricks to Teach Your Body

Star Wars Original Trilogy Trivia (Episodes IV-VI)

Star Wars Original Trilogy Trivia (Episodes IV-VI)

Star Wars Prequel Trilogy Trivia (Episodes I-III)

Star Wars Prequel Trilogy Trivia (Episodes I-III)

Jan Van Eyck and the Man In A Red Turban

Jan Van Eyck and the Man In A Red Turban

Disclaimer

Disclaimer

Tragic Heroes

Tragic Heroes

Algorithms

Algorithms

Bhagavad Gita

Bhagavad Gita

(Tesla) - The Tesla Magnetic Car Engine

(Tesla) - The Tesla Magnetic Car Engine

Physical Modelling Synthesis Overview

Physical Modelling Synthesis Overview

Do you admire Leonardo da Vinci?

Do you admire Leonardo da Vinci?

Acetone Peroxide

Acetone Peroxide