Ownership concentration, corporate governance and firm performance: evidence from Pakistan.
Javid, Attiya Y. ; Iqbal, Robina
The study investigates the determinants of ownership concentration,
the effect of ownership concentration on the firm's performance
with the sample of sixty representative firms from different
manufacturing sectors of the Pakistan's economy during 2003 to
2008. The results suggest that firms where ownership is concentrated
they do not adopt better governance practices and disclose less, however
board composition has positive and significant role. The firm specific
factors affect the concentration of ownership more, the more investment
opportunities provides greater incentives for ownership concentration,
however, size has opposite effect and leads to diverse ownership to get
wider access to funds and share ownership. The results reveal that in
Pakistan corporations have more concentration of ownership which is the
response of weak legal environment. The concentration of ownership by
top five block-holders seems to have positive effect on firms'
profitability and performance measures. The family, foreign and director
ownership also has positive affect on firm performance, however firm
performance is not effected by financial institutions' ownership.
The broad implication that emerges from this study is that ownership
concentration is an endogenous response of poor legal protection of the
investors and seems to have significant effect on firm performance. It
requires implementation of corporate governance reforms at most at par
with real sector and financial sector reforms.
JEL classification: G3 F3
Keywords: Ownership Concentration, Corporate Governance, Firm
Performance, Panel Data
1. INTRODUCTION
The nature of relation between the ownership structure and
corporate governance structure has been the core issue in the corporate
governance literature. From a firms' perspective, ownership
structure determines the firms' profitability, enjoyed by different
stake-holders. In particular, ownership structure is an incentive device
for reducing the agency costs associated with the separation of
ownership and management, which can be used to protect property rights
of the firm [Barbosa and Louri (2002)]. With the development of
corporate governance, many corporations owned by disperse shareholders
and are controlled by hire manager. As a results incorporated firms
whose owners are dispersed and each of them owns a small fraction of
total outstanding shares, tend to under-perform as indicated by Berle
and Means (1932). Latter this theoretical relationship between a
firm's ownership structure and its performance is empirically
examined by Jensen and Meckling (1976) and Shlefier and Vishny (1986).
In most of developing markets including Pakistan, the closely held firms (family or state-controlled firms or firms held by corporations
and by financial institutions) dominate the economic landscape. The main
agency problem is not the manager-shareholder conflict but rather the
risk of expropriation by the dominant or controlling shareholder at the
expense of minority shareholders. The agency problem in these markets is
that control is often obtained through complex pyramid structures, (1)
interlock directorship, (2) cross shareholdings, (3) voting pacts and/or
dual class voting shares that allow the ultimate owner to maintain
(voting) control while owning a small fraction of ownership (cash flow
rights). The dominant shareholder makes the decisions but does not bear
full cost. The negative impact that large family shareholders can have
on firm value can be even greater when family members hold executive
positions in the firm. The choice of a family member as Chief Executive
Officer (CEO) can have a significant impact if the individual does not
have the talent, expertise or competency to run the business. The
opportunity cost created by a suboptimal appointment will be shared by
all shareholders while the private benefits accrue entirely to the
family [Peres-Gonzalez (2001)].
There is another presumption in the literature that large
shareholders have power and stronger incentive to ensure shareholder
value maximisation [Jensen and Meckling (1976); Zeckhouser and Pound
(1990); Burkart (1997)]. The empirical evidence on corporate governance
suggests that large owners have stronger incentive and better
opportunities to exercise control over manager than small shareholders.
Claessen, Djankov and Pohl (1996 and 1999) find evidence of a positive
relation between shareholding concentration and firm performance,
Kocenda and Svejnar (2002) only partly confirmed that observation.
Block-holder ownership above a certain level may lead to entrenchment of
owner-mangers that expropriate the wealth of minority shareholders [Fama
and Jensen (1983); Morck, Shleifer, and Vishny (1988); Shleifer and
Vishny (1986)]. A negative effect of market value on ownership
concentration is proposed and supported by Demsetz and Lehn (1985). The
literature on corporate governance also pays much attention to the issue
of shareholders identity. The implication is that it matters not only
how much equity a shareholder owns, but also who is this shareholder--a
family, a private person, worker, manager, financial institution or
foreign enterprise. However much of the existing literature is based on
the functioning of developed markets' firms, and therefore presumes
a wider dispersion in ownership structure than one find in developing
markets like Pakistan where large share holdings are common.
La Porta, Lopez-de-Silanes, Shleifer and Vishny (1997, 1998, 1999
and 2000) have shown that the countries with weak legal environment, the
original owners tries to maintain large positions in their corporations
which results in concentration of ownership. Equity ownership by
insiders can align insider interest with those of shareholders, thereby
leading to greater firm value [Klapper and Love (2002)]. In
underdeveloped markets in addition to weak legal enforcement reasons,
due to underdeveloped nature of financial markets that would allow
limited access to external financing and result in predominance of
family firms [La Porta, et al. (1997, 1998); Pistor, Raiser, and Gelfer
(2000)]. In case of Pakistan the majority of the firms are owned by the
family or institution [Cheema, Bari, and Saddique (2003)]. Further the
researchers have comprehensively studied the conflict between managers
and owners regarding the functioning of the firm for developed markets,
although, the research on understanding the differences in behaviour of
different shareholder identities is limited for emerging markets.
Corporate Governance reforms started with the introduction of
Corporate Governance Ordinance in 2002. There is little work done to
examine the association between corporate governance and corporate
ownership pattern in case of Pakistan. Cheema, et al. (2003) identify
only the nature of corporate ownership structure in Pakistan without
analysing its impact on corporate performance. The present study tries
to fill the gap of needed research area on the relation between
corporate ownership and corporate governance in context of Pakistan.
The main focus of this study is to investigate whether the equity
ownership structure matters in case of Pakistan and its implications for
corporate governance and corporate valuation. The rest of the study is
organised as follows. Section 2 reviews the important empirical studies concerning the relationship between corporate governance, ownership
structure and corporate value. Section 3 describes the empirical
specification of the model and Section 4 presents the discussion of the
empirical results. Last section concludes this study.
2. REVIEW OF LITERATURE
After the influential study of Berle and Means (1932) the
separation of corporate ownership from control has given rise to large
literature devoted to elaborating, refuting or testing it. Hassen (1983)
argues that if, as Berle and Mean claim, corporate officers are
promoting their own financial interests at the expense of the
shareholders, then the remedy is to encourage shareholders to pay an
active role in nominating and electing directors and thus influence the
selection of the officers who run the enterprise. While Jensen and
Meckling (1976) argue that introduction of managerial share ownership
may reduce these agency problems, thus aligning the interest of managers
and shareholders. They assert that firm value is reduced when ownership
and control are separated due to added costs of monitoring and the
managers participate in activities that may not enhance firm value for
the owners. However, Fama (1980) and Fama and Jensen (1983a, 1983b,
1985) maintain that there are efficiencies to separating ownership and
control into decision-making and risk-bearing functions which make
dispersed ownership advantageous because the efficiency gains outweigh the agency costs. The findings of Graft (1950) and Feinberg (1975)
suggest that organisations with combined ownership and control,
owner-operators may choose to exchange profits for other benefits, such
as choosing current over future consumption [Fama and Jensen (1985)] and
on-the-job non-pecuniary consumption [Demsetz (1983)]. Kuznetsov and
Muravyev (2001) argue that concentrated ownership has its costs when
large shareholders, capable to influence corporate decision directly,
maximise value for themselves and deprive small owners of their part of
residual income. Other negative consequences of ownership concentration
includes raised cost of capital due to lower market liquidity or
decrease diversification opportunities on the part of the investors
[Fama and Jensen (1983)], prevents additional monitoring of managers by
the stock market available under diffused ownership with high liquidity
of shares [Holmstrom and Tirole (1993)]. La Porta, et al. (1999),
Claessens, et al. (2000) and Faccio and Lang (2002) find that publicly
traded companies in most countries possess a higher level of ownership
concentration. Yeh (2003) in Taiwan, Dzieranowski and Tamowicz (2004) in
Poland and Cheema, et al. (2003) in Pakistan find that the
companies' shares are common concentrated in the hand of largest
shareholders.
When shareholders are too diffused to monitor managers, corporate
assets can be used for the benefit of the managers rather than for
maximising shareholder wealth. Therefore a solution to this problem is
to give managers equity stake in the firm. Doing so will resolve the
moral hazard problem by aligning managerial interests with of
shareholders Himmelberg, Hubbard, and Palia (199.9). Stulz (1988)
demonstrate that sufficiently high managerial ownership, by allowing
managers to block takeover bids, can lower firm value. Using US data,
Morck, et al. (1988), McConnell and Servaes (1990, 1995), Hermalin and
Weisbch (1991); and Holderness, Kroszner and Sheehan (1999) all find
firm value to rise with low levels of managerial ownership and to fall
with higher levels of managerial ownership.
As regards the effects of foreign investment on firm performance,
it is argued that the observed higher productivity of foreign-owned firm
because they are disproportionately concentrated in high productive
sectors [Griffith (1999) and Oulton (2000)], by active monitoring,
complementing the inadequate or inefficient monitoring of domestic
institutions Choi and Yoo (2005), source of not only financing but also
scarce monitoring skills and control-enabling property rights in
emerging markets [Khanna and Palepu (1999)], foreign shareholders
outperform firm in which foreign shareholders exercise effective control
[Chhibber and Majumdar (1999)].
There is an extensive theoretical literature on the role and
incentive of financial institutions/banks monitoring non-financial
corporations. Chirinko, Ees, Garretsen and Sterken (1999) explain that
financial institutions might be important mainly because of their role
as supplier of debt but also as equity holder and their representation
on supervisory board. Jensen (1989) argues that joint ownership of debt
and equity by large informed investors (such as Japanese bank) results
in stringent managerial monitoring and create strong incentive for
managers to make value-maximising decisions. Gedajlovic and Shapiro
(2002) are also of the view that financial institutions are well
positioned to monitor the manager of the firm within their network.
Lichtenberg and Pushner (1994) study support the proposition that equity
ownership by financial Institution in Japan effectively substitute for
the missing external takeover (4) market by resulting in monitoring and
intervening when necessary, thus reducing the incidence and severity of
lapses from efficient behavior. Sheard (1989, 1991) and Morck and
Nakamura (1999) propose that financial institution equity block
primarily as anti-takeover barriers. The firm performance varies
substantially for different types of owners. Pakistan where large share
holdings are common [La Porta, et al. (1999); Cheema, et al. (2003)], it
seems more interesting to explore the link between concentration of
ownership and its identity with performance.
3. METHODOLOGICAL FRAMEWORK AND DATA
The corporate governance literature makes an important distinction
between ownership of voting rights and ownership of cash flow rights.
Corporate ownership is measured by cash-flow rights, and control is
measured by voting rights [Faccio and Lang (2001)]. If controlling
shareholders have a majority of voting rights but own negligible cash
flow rights, they have little incentive to take steps to increase the
value of the firm's equity. However, as controlling
shareholders' ownership of cash flow rights increases, any action
they take to benefit themselves at the expense of other equity holders
has a cost in that it decreases the value of the shares controlling
shareholders own. If controlling shareholders own almost all of the cash
flow rights, it makes little sense for them to expend resources to
extract private benefits at the expense of minority shareholders
[Doidge, Karolyi, Lins and Stulz (2005)].
The definition of the ownership in this study relies on cash flow
rights of equity stakes rather than on voting rights. (5) The ownership
variables included are: ownership concentration (T5), managerial
shareholding (Dir) separately to access block-holders and directors
ownership affects on performance of across firms. To delve deeper in to
this issue the concentration of ownership is split into four separate
groups of owners: family owners (fam), foreign owners (for), financial
institution owners (fin) and individual owners (ind). The natural
logarithm of the percentage of shares held by each category of ownership
type is used. To reduce arbitrariness the construction of our ownership
variables is either based on legal requirements by Pakistani law or is
supported by previous empirical literature.
The top five shareholders as proxy for the ownership concentration
is used to analysis that whether corporate ownership affects corporate
governance and corporate performance or not. In top five shareholders
there is no distinguish between different categories of shareholders.
Any cut-off level for inclusion of any shareholder in top five
categories is not used. (6) The family ownership is considered as
percentage of share held by husband, wife, son, and daughter and other
family members, whose surname are same as family members where the
founder or a member of his or her family by either blood or marriage.
Foreign ownership are defined as percentage share held by companies
which are incorporated outside Pakistan but have a place of business in
Pakistan under the companies Ordinance, 1984, "Foreign
Companies". The Ordinance also defines a foreign subsidiary as a
company in which more than 50 percent of the equity is held by a single
foreign company. In Pakistan there is no legal limit by the government
for minimum and maximum level of equity holding by foreign investors as
compare to India where no foreign investor hold more than 51 percent
equity stakes of a firm.
Financial Institutions/Banks Ownership (7) is defined as financial
institutions in the sample represent legal minority shareholder (holding
at least 10 percent of share holders on average). (8) The percentage of
total equity shares mainly held by Banks, National Investment Trust
(NIT), a unit trust and Investment Corporation of Pakistan (ICP) that is
a development financial institution are included. The reforms of the
1990s have transformed the structure of the financial sector in
Pakistan. In order to increase competition the government started
privatising the national banks and other financial institutions. The
assets share of banking institutions in the private sector has increased
from 7.8 percent in 1990 to about 55 percent in 2002 [Cheema, et al.
(2003)]. However their equity investment remains low as compare to ICP
and NIT. (9) Consequently, the effect of financial institution's
ownership on performance in case of Pakistan is likely to be different.
Director ownership is the share ownership by management and board of
directors varies substantially across firms. The shares held by
directors and officers irrespective of whether managers are part of
family or a professional manager hired by the family or by the foreign
firm.
3.1. Determinants of Ownership Concentration
The empirical evidence suggests that in Pakistan ownership is
concentrated [Chemma, et al. (2003) and La Porta, et al. (1999)]. Most
firms are closely held either by families, directors, foreign or
institution owners. To distinguish among different ownership type in the
analysis, the ownership type is controlled in the ownership model and
separate estimate of determinants of ownership for directors'
ownership are also provided. As mentioned above a block holder is
defined to be any entity owning more than 10 percent of the firm equity.
In the absence of adequate investor protection concentration of
ownership becomes a more important tool to resolve agency conflict
between controlling and minority shareholder [Shleifer and Wolfenson
(2002)]. Therefore the hypothesis tested is that there is association
between concentration of ownership and quality of corporate governance
practices following the empirical specification of the model proposed by
Pistor, et al. (2003), Durnev and Kim (2006) and Klein, et al. (2005) is
used:
[Own.sub.i] = [alpha] + [[beta].sub.1][CGI.sub.i] +
[[beta].sub.2][Inv.sub.i] + [[beta].sub.3]Size +
[[beta].sub.4][Lev.sub.i] + [[beta].sub.5][Lw.sub.i] * [CGI.sub.i] +
[[epsilon].sub.it] ... (1)
In the model [Own.sub.i] is the ownership concentration by top five
shareholders of firm i at time t. [CGL.sub.i] is a vector of corporate
governance index, [Inv.sub.i] is investment opportunities measured by
the past growth in sales, [Lev.sub.i] is leverage defined as book value
of long term debt/book value of total asset, [Lw.sub.i] is rule of law
that is used for the proxy of enforcement of law, and [Size.sub.i] is
measured by the log of total asset. [[epsilon].sub.it] is random error
term.
It is expected that shareholders with greater cash flow rights
practice lower quality corporate governance. The owner shareholders of
the firm with more profitable investment opportunities divert less tbr
outside shareholders gain and practice high quality governance [Durnev
and Kim (2006) and Johnson, et al. (2000)]. There is opposite finding
that growing firms dilute their ownership to spread risk of expansion
[Shleifer and Wolfenson (2002)]. As regards the firm level variables,
the firm size is used as control variable and expects to have an inverse
relationship between firm size and ownership concentration due the risk
neutral and risk averting effects because the market value of a given
stake of ownership is greater in larger firm, this higher price should
reduce the degree of concentration. At the same time risk aversion should discourage any attempt to preserve the concentration of ownership
in face of larger capital because this would require the owners to
allocate more of their wealth to single venture [Domsetz and Lehn
(1985)]. Following La Porta, et al. (1998) the ownership concentration
of the firm is related to legal environment of the country, the rule of
law index as a proxy for the efficiency of the legal environment is used
as interactive variable. It is expected to find negative relationship
between ownership concentration and law enforcement because in countries
like Pakistan with poor investor protection ownership concentration
might become a substitute for legal protection as shareholders may need
to own more capital in order to exercise control.
3.2. Ownership Concentration and Firm Performance
The deficiency of external governance mechanism that is weakness of
investor protection and absence of well developed market for corporate
control leads investor to rely on governance structure that is dominated
by highly concentrated ownership. In this section the impact of
ownership concentration on the firm performance is examined. The firm
performance improves when ownership and managerial interest are merged
through concentration of ownership [Agrawal and Mandeike (1990)]. The
reason is that when major shareholdings are acquired, control can not be
disputed and resulting concentration of ownership might lower or
completely eliminate agency costs. In addition block holders might
provide an opportunity to extract corporate resources for private
benefits in a way that would have a negative effect on firm valuation.
To test the hypothesis that there is a relationship between
concentration of ownership and firm performance, the model suggested by
Pistor, et al. (2003) and Klein, et al. (2005) is estimated. The model
is given below:
[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (2)
Where [Perf.sub.i] is measure of performance for firm i at time t,
return on assets ROA, return on equity (ROE) and Tobin's Q,
remaining variables are same as defined for model (1). When profitable
investment opportunities are there, the controlling shareholders divert
to concentrated ownership and corporate valuation become higher. The
positive relationship between ownership and firm value is higher in weak
legal environment [La Porta, et al. (2002); Durnev and Kim (2006)]. It
is expected that firms with better investment opportunities, better
corporate governance practices should have higher valuation.
3.3. Ownership Identity and Firm Performance
Since the type of ownership concentration might vary across firms
according to the identity of large shareholders. It is postulated that
the relationship between larger shareholder and firm performance depends
on who the large shareholders are. The concentration of ownership is
split into four separate groups: family ownership (Fam), financial
institutional ownership (Fin), foreign ownership (Fore) and individual
ownership (Ind). To avoid multicolinearity the managerial ownership is
not included in the model. The affect of managerial ownership on
performance is also investigated separately. The following model
proposed by Pistor, et al. (2003) is estimated to determine the
relationship between ownership identity and firm performance:
[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (3)
Where [Own.sub.ij] is the percentage of share held by owner of type
j of firm i at time t and other variables are the same as used in model
(1) and (2). There has been increasing concern about the endogeneity
issue of ownership variables in literature [Himmelberg, et al. (1999)
and Demsetz and Lehn (1985)]. The system generalised method of moments
(GMM) estimation technique is used on the panel data to deal with this
issue. The lag dependent and explanatory variables are used as
instruments following Arellano and Bond (1991).
3.4. Data
To assess the relationship corporate governance and ownership
structure at firm level, the data of 60 non-financial firms listed at
Karachi Stock Exchange which are most active and representative of all
non-financial sectors are used. The data set is obtained from the annual
reports of these firms for the year 2003 to 2008. The corporation fully
owned by the government of Pakistan and corporation from financial
sector such as bank and insurance companies because valuation ratios for
financial corporations are not comparable to those of non-financial
corporations The analysis is started from 2003 for our analysis because
the Corporate Governance Code 2002 start implementation from 2003 and
public information about listed companies' detailed ownership
structure became available for the first time only in 2003. For each
firm the ownership structure information is obtained from the
company's annual reports which are required by the Company
Ordinance, 1984 in form 34 and Code of Corporate Governance under clause
XIX (i). The block-holder is defined as any individual, director,
associated company, foreign investor or financial institution has 10
percent or more shareholdings. The 10 percent rule is applied because 10
percent or more shareholding has the ability to block company's
special resolution. The Category and Pattern of Shareholding report the
names and holdings of large shareholders, directors, specifies any
family relations between them, and identifies the owners of companies
that are large shareholders as well intuitional holdings and related
parties' holdings. With this data set the ownership categories
directors' shareholdings, financial institution holdings foreign
investor's holdings, and block-holder with 10 percent shareholding
are constructed.
The corporate governance index and disclosure and transparency
index are used which are developed by the authors in their study [Javid
and Iqbal (2007)]. In order to construct corporate governance index for
the firms listed on KSE, a broad, multifactor corporate governance
rating is done which is based on the data obtained from the annual
reports of the firms submitted to SECP. The index construction is as
follows: for every firm, twenty-two governance proxies or indicators are
selected; these indicators are categorised into three main themes. The
three categories or sub-indices consist of: eight factors for the board
composition index, seven for ownership and shareholdings index and seven
for transparency, disclosure and audit index. The weighting in the
construction of index is based on subjective judgments. The assigned
priorities amongst and within each category is guided by empirical
literature and financial experts in this area. The maximum score is 100,
a score of 100 is assigned if factor is observed, 80 if largely
observed, 50 for partially observed and 0 if it is not observed. The
average is taken out for all the factors belonging to the sub-index and
we arrive at the rating of one sub-index. (10) By taking the average of
three sub-indices we obtain the aggregate corporate governance index for
each firm in the sample.
Data on rule of law has been taken from World Bank governance
indicators. The ranking of rule of law as ranging from 0 to 1 for
Pakistan is 0.34 as average of six years. That indicates very poor legal
environment for Pakistan in term of enforcement of law. (11) Financial
data on the sample firms are compiled from the balance sheets, profit
and loss accounts, cash flows statement and notes to the accounts of the
annual reports of the corporations. The size is defined as natural
logarithm of total asset and growth of sales is taken as investment
opportunities. The leverage is defined as ratio of book value of long
term debt to book value of total asset. The data of all these variables
are obtained from the annual reports of the listed firms in the sample.
4. EMPIRICAL FINDINGS
The analysis is started by exploring the determinants of ownership
concentration. The measure of ownership concentration is defined as
percentage of share owned by the largest five shareholders in a firm,
and a block is defied as to be any entity owning more than 10 percent of
the firm's equity. The model (1) is estimated for five
specifications with aggregate [CGl.sub.i] index and with sub-indices
that are board composition index, shareholdings and audit index,
disclosure and transparency index. The results are presented in Table1.
The results suggest that there is negative relationship between
ownership concentration and quality of corporate governance. Durnev and
Kim (2006) find there is positive relation between cash-flow rights and
corporate governance, however, Morck, et al. (1988) and McConnell and
Servaes (1990) argue that greater ownership concentration may align
their interest with minority shareholders, but it results in greater
degree of managerial entrenchment. The transparency scores score when
included in the model the results show that the relationships become
insignificant and show that this governance indicator do not affect the
concentration of ownership. There is no reason to expect that firms
where ownership is concentrated disclose more, however board composition
has positive and significant role. This negative coefficient of law
variable with corporate governance index suggests that the relationship
between ownership concentration and quality of corporate governance is
stronger in weak legal regime. This indicates that in the absence of
adequate legal protection for investor, concentration of ownership
become an instrument to resolve agency conflict between controlling and
minority shareholders. This result confirms that ownership concentration
is indeed a response of poor legal protection [La Porta, et al. (1999);
Durnev and Kim (2006)]. The leverage is not a significant determinant of
ownership concentration in all cases. The effect of investment
opportunities is always positive and significant in all the models,
which shows that more investment opportunities leads to more
concentration of ownership and when firm suffers from a substantial drop
in profitable investment opportunities, the controlling shareholders
divert more corporate resources. Johnson (2000) documents such behaviour
by Asian firms before the East Asian crisis. The impact of firm size and
ownership concentration is negative indicating that ownership
concentration is significantly lower as the firm size expands.
As regards the results of effect of ownership concentration and
firm valuation, the regression results are based on two accounting
measures (ROA and ROE) and market measure that is Q-ratio for firm
performance. Different specifications for each performance measure are
estimated. The results are consistent with several empirical findings
that document a positive and significant relationship between ownership
concentration by top five shareholders and firm performance implying
that ownership concentration matters in determining firm's value.
Our result is in accordance with the findings of Lehmann and Weiggand
(2000) for Germany, Leech and Leahy (1991) and Mudambi and Nicosia
(1998) for UK. Another important finding is the favourable effect that
market bestows on firms that follows good practices and is transparent.
The positive and significant coefficient of corporate governance score
and disclosure and transparency score imply that the firm that practice
good governance and disclose more achieve superior performance compared
to other firms. However, firm level variable show significant
relationship with firm performance. The results reveal that large size
firms are more likely to achieve better performance. The reason might be
that the competition affects and the market power of large-sized firms
enable them to out-perform small-size firms in Pakistan. Regarding other
firm level variables the firms with more investment opportunities
outperform compared to those which have less investment opportunities.
The interaction term of corporate governance index with law enforcement
term are not significant in any model suggesting that firm performance
is not affected by rule of law in case of Pakistani firms where legal
environment is weak. (Table 2)
The type of ownership concentration varies across firms according
to the identity of large shareholders, the relationship between firm
performance and ownership type depends on who are the large
shareholders. The concentration of ownership is split into four separate
groups of owners: family ownership, foreign ownership, individual
ownership and institutional ownership. The results reported in Table 3
indicate family and foreign ownership concentration have positive and
significant effect on firm performance. The results do not indicate any
impact of financial institution ownership and individual ownership
concentration on firm value in any of our models. These findings are
consistent with theoretical argument claiming that family owners and
foreign owners bring better governance and monitoring practices. The
positive and significant results of the family shareholdings are due to
the fact that families control can reduce classical agency problem
between owner and managers [Fama and Jensen (1983)] as shareholders with
a large stake in the company have a greater incentive to play an active
role in corporate decisions because they partially internalised the
benefits from their monitoring efforts. James (1999) posits that
families have longer investment horizons, leading to greater investment
efficiency. Stein (1989) shows the presence of shareholders with
relative long investment horizons can mitigate the incentive for myopic investment decisions by managers. Moreover the family's historical
presence, large equity position, and control of management and director
posts place them in an extraordinary position to influence and monitor
the firm.
The positive affect of foreign ownership on performance is
supported by Dahlquist and Robertson (2001). They argue that foreign
investors can complement the inadequate or inefficient monitoring of
domestic institutions. Government authorities can effectively import the
monitoring capability of institutional investors by opening local stock
markets to foreign investors. In case of financial institution ownership
it has no significant impact because firstly, the nominees on the board
are typically bureaucrats and retired army officers with minimal
expertise in corporate matters. Secondly, even if these agents of the
government are equipped for the task of oversight in corporate matters
they do not have a strong incentive to be effective monitors as their
tenure and career prospects are rarely affected by the performance of
the companies in which they serve on the board as nominees.
The owner-managers shows positive and significant impact on the
firm performance in Table 4 and this result is in agreement with Sarkar and Sarkar (2000) who find that block-holdings by directors'
increase firm value. Owner managers have a strong incentive to manage
their companies well and generate wealth as their fortunes are tied to
the well being of the company. They are after all the promoters of the
company and they have the greatest stakes (in tangible as well in
intangible terms) in the success and failures of their companies. They
have also excellent knowledge of the firm.
The corporate governance index and disclosure and transparency have
positive affect on performance as reported in Tables 3 and 4. The
results support our previous findings that size and investment
opportunities have significant effect in most of the models. As regards
the quality of legal environment the interaction terms of rule of law
with ownership concentration shows no relationship with firm
performance; which suggests that concentration of ownership is
substitute for weak legal protection. [La Porta, et al. (2000)].
5. SUMMARY AND CONCLUSION
This study determines the factors influencing the ownership
concentration, and the effect of this on the other aspects such as firm
performance using representative sample of 60 firms for the period 2003
to 2008. The results reveal that in Pakistan corporations has more
concentration of ownership which is the response of weak legal
environment and this result validates the La Porta, et al. (1997, 1998,
1999, 2000) findings. The concentration of ownership seems to have
positive effect on firms' profitability and performance measures.
There is negative association between corporate governance practices and
disclosures and transparency with concentration of ownership. The
identity of ownership matters more than the concentration of ownership.
The family, foreign and director ownership has positive affect on firm
performance. The results indicate that firm specific factors affect more
in concentration of ownership. The findings reveal that more investment
opportunities provides greater opportunity to for ownership
concentration, however, size has opposite effect and leads to delusion of ownership. It results in diverse ownership to get wider access to
funds and share ownership. These results are consistent with studies
Boubakri, et al. (2003). The legal environment has no impact on
concentration of ownership or on firm performance [La Porta, et al.
(2002)]. The broad implication that emerges from this study is that
ownership concentration is an endogenous response of poor legal
protection of the investors and seems to have significant effect on firm
performance. It requires implementation of corporate governance reforms
at most at par with real sector and financial sector reforms.
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Robina Iqbal <robinaiqbal@gmail.com> is Freelance Researcher.
(1) Pyramids are a particular form of inter-firm shareholding
arrangement in which firm A holds a stake in firm B, which holds a stake
in firm C. The distinguishing characteristic of pyramid arrangement is
that firm A is attempting to exercise control over firm C while
minimising its financial investment in firm C, either directly or
indirectly.
(2) That occurs when a firm's employee sits on other
firm's board, and that firm's employee sits on the first
firm's board. These employees are generally the Chief Executive
Officer (CEO) or another person high in management of their respective
firms.
(3) Cross-holding means company Y directly or indirectly controls
its own stock.
(4) Takeovers: if a firm is inefficiently operated, then there is
scope for improved performance if an outsider (or some of current
shareholders) take over the firm, replaces its management, and initiates
a new business strategy [Yafeh (2001)].
(5) Controlling shareholders use pyramiding schemes and
cross-holding as a means of separating the cash flow and voting fights,
and to enhance their company control rights. To measure such structure,
the data for both the ultimate cash flow ownership stakes and voting
power held by the management group and its family for all of firms is
needed, but data on ultimate voting rights is not available. However to
the extent that effective managerial and family control can be
established at some level below 100 percent, control and cash flow
rights will inherently be separated. Generally, managerial control of 51
percent of the shares will confer unequivocal control rights. In such a
case, controlling managers that divert one dollar from the firm for
personal gain will bear at most 51 cents of the cost. Any further
separation of control from cash flow rights via pyramids and superior
voting shares may be a second-order effect [Doidge, et al. (2005)].
(6) The idea behind 10 percent of the shares is that the passage of
special resolution under the Pakistan Companies ordinance of 1984, as a
result of which alteration in a firm's activities can be made only
by the 75 percent majority vote of shareholders in favour of such
resolution. Only 10 percent class of shareholders have the ability to
block the members' special resolutions that are necessary to make
significant changes. Moreover, disclosure of the aggregate of
shareholding, restriction on the sale of shares to public are all
associated with more than 10 percent holding of shares.
(7) Under the financial institutions ordnance, 2001 "Financial
Institution" are defined as; (i) any company whether incorporated
within or outside Pakistan which transacts the business of banking or
any associated or ancillary business in Pakistan through its branches
within or outside Pakistan and includes a government savings bank, but
excludes the State Bank of Pakistan; (ii) a Modaraba or Modaraba
management company, leasing company, investment bank, venture capital
company, financing company, unit trust or mutual fund of any kind and
credit or investment institution, corporation or company; and (iii) any
company authorised by law to carry on any similar business, as the
Federal Government may by notification in the official Gazette, specify
(The Financial Institutions Ordinance, 2001, XLVI of 2001).
(8) The Company Ordinance, 1984 and the Code of Corporate
Governance do not recognise minority shareholders with a shareholding
below 10 percent. The minimum threshold for seeking remedy from the
Court against mismanagement and oppression requires initiation of the
company by no less than 20 percent of the shareholders. Shareholders
representing 10 percent can apply to SECP for appointment for inspector
for investigation into the affairs of the company. See section 263 and
290 of the Company Ordinance, 1984
(9) According to Cheema, et a1.(2003) in their investigation of
investment composition of local private companies the sole contribution
of ICP/NIT in equity capital of Textile sector is 8.4 percent as compare
to 5.1 percent of other financial institutions, and l l.1 in Non-Textile
sector as compare to 8.2 percent of other financial institutions.
(10) Sub-Index includes (i) Board composition index, (ii) The
ownership and shareholdings Index, (iii) Disclosure and Transparency
index.
(11) Although as Pakistan belongs to common law countries legal
origin. In view of La Porta, et al. (I997) common law countries provide
strong investor protection in term of law on books. The ranking of rule
of law indicate the fact that enforcement of law is very low against
high ranking on law on books.
Table 1
Determinants of Concentration of Ownership by Top Five)
Independent Variables 1 2 3 4
[CGI.sub.i] -0.02 **
(-1.56)
Board 0.01 0.20 *
(3.98) (4.61)
Disc -0.01 0.17
(-0.51) (0.93)
Inv 0.56* 0.73* 0.56* 0.07 **
(3.14) (4.04) (3.14) (2.22)
Size -0.01 * -0.11 * -0.01 -0.01 ***
(-2.30) (-7.43) (-2.53) (-1.59)
Lev 0.01 0.01 0.01 0.08
(0.28) (0.40) (0.64) (0.76)
Lw * CGI 0.02 -0.05 -0.06 -0.17
(0.27) (-0.97) (-0.45) (-1.57)
Constant -0.50 0.48 0.38 -.0.76
(-2.86). (2.75) (1.58) (5.48)
[R.sup.2] 0.28 0.31 0.28 0.34
Note: The *, ** and *** indicates the significance levels at I
percent, 5 percent, and 10 percent respectively.
The values in parenthesis are t-statistics.
Table 2
Evidence on Performance and Ownership Concentration by Top Five
Tobin Q
Owni 0.03 ** 0.12 * 0.11 *
(1.51) (4.79) (4.41)
[CGI.sub.i] 0.01
(0.49)
[Disc.sub.i] 0.04 *
(2.83)
Inv 0.03 *** 0.03 *** 0.03 ***
(1.41) (1.42) (1.39)
Size 0.01 * 0.02 * 0.01 **
(2.33) (2.08) (1.84)
Law * [CGI.sub.i] -0.02 -0.01 *
(0.64) (-2.22)
Intercept 0.11 1.30 1.19
(10.44) (7.87) (6.74)
R Square 0.33 0.34 0.36
ROA
Owni 0.12 0.12 * 0.69 **
(4.72) (1.86) (1.54)
[CGI.sub.i] 0.29 ***
(1.47)
[Disc.sub.i] 0.01 **
(1.86)
Inv 0.03 ** 0.59 *** 0.01 **
(1.41) (1.48) (1.84)
Size 0.02 * 0.13 0.15 ***
(2.37) (3.85) (4.39)
Law * [CGI.sub.i] 0.28 -0.10
(0.16) (-0.57)
Intercept 1.18 0.16 -1.10
(10.44) (2.07) (-1.79)
R Square 0.28 0.29 0.33
ROE
Owni 0.001 0.01 0.13 *
(0.36) (1.18) (2.14)
[CGI.sub.i] 0.03 **
(1.78)
[Disc.sub.i] 0.01 **
(1.67)
Inv 0.48 ** 0.001 0.02 **
(1.44) (0.75) (1.66)
Size 0.36 ** 0.12 ** 0.12
(1.97) (1.72) (1.01)
Law * [CGI.sub.i] -0.01 -0.03
(-1.19) (-0.57)
Intercept 0.37 1.65 1.02
(0.68) (1.94) (2.01)
R Square 0.32 0.35 0.34
Note. The *, ** and *** indicates the significance levels
at 1 percent, 5 percent, and 10 percent respectively.
The values in parenthesis are t-statistics.
Table 3
Evidence on Performance and Ownership Identity
Tobin Q
Fam 0.22 ** 0.14 * 0.09 **
(2.06) (1.97) (1.85)
Fore 0.03 * 0.02 ** 0.01 **
(1.98) (1.86) (1.96)
Fii 0.13 0.10 0.10
(1.21) (1.14) (0.74)
[Indv.sub.i] 0.19 0.10 0.17 ***
(1.00) (1.01) (1.61)
[CGI.sub.i] 0.11 **
(1.86)
[Disc.sub.i] 0.03 **
(1.96)
[Size.sub.i] 0.04 0.07 * 0.03 **
(0.90) (2.02) (1.82)
Inv 0.03 * 0.04 *** 0.02 **
(2.02) (1.68) (1.79)
Law * [CGI.sub.i] 0.02 0.001
(0.97) (1.02)
Intercept -0.62 -2.13 -2.77
(-0.71) (-1.50) (-2.01)
[R.sup.2] 0.30 0.27 0.25
ROA
Fam 0.12 ** 0.21 * 0.17 *
(2.27) (2.01) (1.98)
Fore 0.04 *** 0.02 *** 0.13 **
(1.66) (1.76) (1.97)
Fii 0.05 0.13 0.04
(1.41) (1.36) (1.07)
[Indv.sub.i] 0.04 0.11 0.03
(1.33) (0.44) (1.04
[CGI.sub.i] 0.15 **
(1.89)
[Disc.sub.i] 0.02 **
(1.74)
[Size.sub.i] 0.04 ** 0.01 ** 0.01 **
(1.83) (1.84) (1.98)
Inv 0.02 0.02 * 0.01 *
(1.40) (1.91) (1.89)
Law * [CGI.sub.i] -0.12 0.01
(1.04) (1.11)
Intercept -0.77 -0.80 -0.54
(-0.81) (-0.38) (-1.55)
[R.sup.2] 0.28 0.29 0.30
ROE
Fam 0.21 * 0.08 * 0.05 *
(1.95) (1.88) (1.77)
Fore 0.01 0.13 ** 0.02 ***
(1.73) (1.85) (1.57)
Fii 0.01 *** 0.04 0.01
(1.67) (0.82) (1.13)
[Indv.sub.i] 0.02 0.01 0.12
(0.51) (0.51) (0.97)
[CGI.sub.i] 0.21 ***
(1.73)
[Disc.sub.i] 0.01 ***
(1.54)
[Size.sub.i] 0.01 * 0.02 * 0.01 *
(2.36) (2.01) (1.87)
Inv 0.001 0.02 * 0.01 **
(0.95) (1.98) (1.69)
Law * [CGI.sub.i] 0.02 0.11
(1.06) (0.49)
Intercept 1.65 -2.15 -1.11
(0.94) (-2.31) (-2.24)
[R.sup.2] 0.33 0.35 0.38
Note: The *, ** and *** indicates the significance levels
at 1 percent, 5 percent, and 10 percent respectively.
The values in parenthesis are t-statistics.
Table 4
Evidence on Performance and Manager-Ownership
Tobin Q
Dir 0.46 ** 0.24 * 0.11 **
(3.20) (1.88) (1.97)
[CGI.sub.i] 0.11 **
(1.74)
[Disc.sub.i] 0.01 *
(1.96)
Inv 0.01 * 0.03 *** 0.02 **
(1.98) (1.77) (1.82)
Size 0.04 0.27 * 0.13 **
(0.90) (2.02) (1.82)
Law * [CGI.sub.i] 0.02 0.001
(0.97) (1.02)
Intercept -0.62 -2.13 -2.77
(-0.71) (-1.50) (-2.01)
[R.sup.2] 0.30 0.27 0.25
ROA
Dir 0.12 ** 0.21 * 0.27 *
(2.27) (2.01) (2.08)
[CGI.sub.i] 0.04 **
(1.89)
[Disc.sub.i] 0.02 **
(1.74)
Inv 0.02 *** 0.02 * 0.01 *
(1.64) (1.91) (1.89)
Size 0.04 ** 0.21 ** 0.10 **
(1.83) (1.84) (2.01)
Law * [CGI.sub.i] -0.12 0.01
(1.04) (1.11)
Intercept -0.77 -0.80 -0.54
(-0.81) (-0.38) (-1.55)
[R.sup.2] 0.28 0.29 0.30
ROE
Dir 0.33 * 0.08 * 0.05 *
(1.95) (2.11) (1.98)
[CGI.sub.i] 0.11 ***
(1.84)
[Disc.sub.i] 0.01 ***
(1.63)
Inv 0.01 0.02 * 0.04 **
(0.95) (1.98) (1.69)
Size 0.25 * 0.03 * 0.02 *
(2.72) (2.72) (1.98)
Law * [CGI.sub.i] 0.004 0.02 0.11
(0.88) (1.06) (0.49)
Intercept 1.65 -2.15 -1.11
(0.94) (-2.31) (-2.24)
[R.sup.2] 0.33 0.35 0.38
Note: The *, ** and *** indicates the significance levels
at 1 percent, 5 percent, and 10 percent respectively.
The values in parenthesis are t-statistics