11/3/2560 Doinefficientstockmarketsdrivebadcorporategovernance?

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Doinefficientstockmarketsdrivebadgovernance?
FritzFoley,SergeyChernenko,RobinGreenwood

01June2010

Whydominorityshareholderscontinuetoholdstockdespitetheriskofexpropriationbycontrolling
shareholders?ThiscolumnprovidestwodecadesofevidencefromJapansuggestingthatmanyinvestorsdo FritzFoley
notforeseetheseconflictsofinterest,evenwhenthereisplentyofdisclosure.Inefficientstockmarketsallow AssociateProfessorintheFinance
majorityshareholdersoftenparentcompaniestoselloverpricedstockonlytobuyitbackatalaterdate. area,HarvardBusinessSchool

3 A A

Oneofthemajoraccomplishmentsofrecentcorporategovernanceresearchhasbeentoexpose
therisksconfrontedbyminorityshareholdersinpubliccompaniesaroundtheglobe.Corporate
ownershipstructuressuchaspyramids,businessgroups,anddualclasssharesleavecontrolinthe
handsofalimitedsetofblockholdersexposingminorityinvestorstopotentialexpropriation.

Why,then,dominorityshareholdersparticipateinthesearrangements?Theprevailingacademic SergeyChernenko
AssistantProfessorattheFisher
viewsinceJensenandMeckling(1976)isthatcapitalmarketsareefficientinthesensethatminority
CollegeofBusinessattheOhio
investorsforeseethepossibilityofexpropriationbycontrollingshareholders.Asaresult,underthis
StateUniversity
view,thesharepricethatminorityinvestorsarewillingtopayreflectstheirrationalexpectationsof
RobinGreenwood
expropriationandotheragencyproblems.Andbecauseoutsideequityisexpensive,controlling
AssociateProfessorattheHarvard
shareholderswillonlyraiseequitycapitalfromminorityinvestorsiftherearecommensurate
BusinessSchool
benefits,suchasattractivegrowthopportunitiesthatthefirmwouldnotbeabletofinanceotherwise.
Don'tMiss
Anewviewonwhyagencyproblemsarise
TheLongEconomicand
PoliticalShadowofHistory,
Inrecentresearch(Chernenkoetal.2010),weproposeanewandalternativeviewforthe Volume3
emergenceofownershipstructuresthatarepronetosevereagencyproblems.Motivatedbythe Michalopoulos,Papaioannou
growingliteraturestudyingtheeffectsofstockmarketmispricingonfirmbehaviour(seeforexample
Apprenticeshipandtherise
Stein1996,ShleiferandVishny2003,andBaker2009),wedevelopasimpleframeworkforthinking ofEurope
abouthowstockmarketmispricingcanoffsetagencycostsandinducecontrollingshareholdersto delaCroix,Doepke,Mokyr
raiseoutsideequity.
QuoVadis?Identity,policy
andthefutureofthe
Ourargumentisasfollows.Supposethatduringsomeperiods,investorsareoveroptimistic,failing EuropeanUnion
toseethepotentialforconflictsofinterestbetweenthemselvesandthecontrollingowner.Under Beck,Underhill
theseconditions,equityisoverpricedrelativetoavaluationwhichfullyaccountsfortheconflictsof
Macroprudentialstresstests:
interestbetweenminorityandmajorityinvestors.Stockmarketmispricinginducesthecontrolling Anewanalyticaltool
shareholdertoselloverpricedequity,subsequentlydivertingresourcestohisbenefit.Inorderto Constncio
returntothepreviousownershipstructureswiththesameagencyproblems,evengreater
Europeanintegrationand
misevaluationisrequired. populism:Addressing
Dahrendorf'squandary
Ourbasicideaismotivatedbythestockmarketperformanceofminorityinvestorsinpubliclyheld Buti,Pichelmann
subsidiariesinJapan.ItiscommonpracticeforlargecompaniesinJapantolisttheirsubsidiarieson
Globalisationandeconomic
thestockmarket,whilemaintainingacontrollingstakethereafter.Althoughsubsidiariesare nationalism
technicallyindependentcompaniesoncetheyarelisted,thepotentialfortheexpropriationof Colantone,Stanig
minorityshareholdersisimmense.InacasestudyofNECElectronics,wedocumenthowparent
WhentheIMFevaluatesthe
companyNECforceditspubliclylistedsubsidiaryNECElectronicstobearbillionsofdollarsof IMF
wastefulR&Dandcapitalexpendituresonbehalfoftheparentcompanysmobilephoneline.But Wyplosz
minorityshareholdersinNECElectronicsdidnotseemtohaveanticipatedthiskindofactivity,and
NeweBook:TheLong
theyearnedpostlistingreturnsthatwerewellbelowthoseoftheaggregatestockmarket,andwell EconomicandPolitical
belowthereturnsearnedbyshareholdersoftheparentcompany. ShadowofHistoryAfrica
andAsia
UsingalargesampleofsubsidiarieslistedinJapanbetween1980and2005,wefindthatthe Michalopoulos,Papaioannou
experienceofNECElectronicsisnotunique.Theevidenceisconsistentwiththreepredictionsthat TheLongEconomicand
followfromourframework. PoliticalShadowofHistory,
Volume2
First,theincentivetodivertresourcesisstrongerwhenacontrollingshareholdermaintainsa Michalopoulos,Papaioannou
smallerownershipstakeafterlistingsotheselistingsrequiremoremispricing.Consistent Crisis,CreditandResource
withthisnotion,wefindthatsubsidiariesinwhichthecontrollingshareholdersellsalarger Misallocation:Evidencefrom
stakeatlistinggeneratelowpostlistingreturns. EuropeduringtheGreat
Recession
Second,wefindthatsubsidiariesthathaveproductmarketrelationshipswiththeirparents Banerjee,Coricelli
alsogeneratelowpostlistingreturns.Thescopeforagencyproblemsishighforthesekinds
ofsubsidiaries,somoremispricingisrequiredtosupportthem.
http://voxeu.org/article/doinefficientstockmarketsdrivebadcorporategovernance 1/3
11/3/2560 Doinefficientstockmarketsdrivebadcorporategovernance?|VOX,CEPRsPolicyPortal
ofsubsidiaries,somoremispricingisrequiredtosupportthem.
NeweBook:TheLong
Third,pricesarelikelytoreverttofundamentalvalue,andwhentheydo,thecontrolling
EconomicandPolitical
shareholderoftenrepurchasesthesubsidiariestoeliminateagencycosts.Wefindthat25%of ShadowofHistory
thesubsidiariesinoursamplearerepurchasedbefore2007,andthatparentshareholders Michalopoulos,Papaioannou
earnpositivereturnswhentheserepurchasesareannounced.
UStariffsareanarbitraryand
regressivetax
Theideathatstockmispricingsupportsthecreationofownershipstructurespronetoagency Furman,Russ,Shambaugh
problemshasimportantimplicationsforcorporategovernanceregulations.Manyregulatory
Publicpolicyinazero
proposalsareaimedatincreaseddisclosureandtransparency.Ourresearchsuggeststhat,by
growthscenario
themselves,moredisclosureandtransparencymaynotbeenoughastheywillnotpreventminority Perotti
shareholdersfromoverpayingforequity.Experimentalevidencesuggeststhatdecisionmakers
Whenbehavioural
oftenignoreconflictsofinterest,evenwhensuchconflictsareprominentlydisclosed(Cainetal.
economicsmeets
2005).Andregulatorsthemselvesoftenexpressconcernthatinvestorswillnotbeableto randomisedcontroltrials
understandconflictsofinterest,evenwhenthereisplentyofdisclosure. French,Oreopoulos

GlobalisationandBrexit
ConsiderforexampletherecentdecisionoftheSecuritiesandFuturesCommissionofHongKong
Colantone,Stanig
toallowsharesoftheUnitedCompanyRUSALtobelistedontheHongKongStockExchange.The
regulatorspreventedretailinvestorsfromparticipating,despitetherisksbeingdisclosedina Thinkglobal,actlocal
thousandpageprospectus. Shafik
Implications Productionfragmentation
andtheglobaltrade
Ourresearchalsocontributestothedebateregardingtheroleofbusinessgroupsinemerging slowdown
economies,inparticulartheextenttowhichbusinessgroupshelpovercomemarketinefficienciesor Timmer,Los,Stehrer,DeVries
engageinrentseekingbehaviour.Withoutdenyingtheirabilitytohelpovercomevariousmarket Unwindingofthepound
inefficiencies,ourresearchsuggeststhattakingadvantageoftemporarystockmispricingcan carrytrade
contributetotheformationofbusinessgroupsandotherownershipstructurespronetoagency Mody
problems. NeweBook|Longterm
Unemploymentafterthe
Finally,beingabletoopportunisticallyraiseoutsideequitywhenitisovervaluedmayreduce GreatRecession:Causesand
remedies
entrepreneursincentivetolobbyforstrongcorporategovernanceregulations.Thiscouldpotentially
Bentolila,Jansen
helpexplainthepersistenceofweakprotectionofminorityshareholdersinmanycountriesaround
theworld. Thelimitationsof
randomisedcontrolledtrials
References Deaton,Cartwright

Knowyourfacts:Poverty
Baker,Malcolm(2009),Capitalmarketdrivencorporatefinance,AnnualReviewofFinancial numbers
Economics,1:181205. Cuesta,Negre,Lakner
Cain,DaylianM,GeorgeLoewenstein,andDonAMoore(2005),Thedirtoncomingclean: Thefundamentalfactors
Perverseeffectsofdisclosingconflictsofinterest,JournalofLegalStudies,34:125. behindtheBrexitvote
Chernenko,Sergey,CFritzFoley,andRobinGreenwood(2010),Agencycosts,mispricing,and Becker,Fetzer,Novy
ownershipstructure,workingpaper.
Foley,CFritz,RobinGreenwoodandJimQuinn(2008),NECElectronics,HarvardBusiness MostRead
SchoolCase,No.209001.
ThisMonth AllTIme
Jensen,MichaelC,andWilliamMeckling(1976),Theoryofthefirm:managerialbehaviour,agency
costs,andownershipstructure,JournalofFinancialEconomics,3:305360. WhentheIMFevaluatesthe
Shleifer,Andrei,andRobertWVishny(2003),Stockmarketdrivenacquisitions,Journalof IMF
Wyplosz
FinancialEconomics,70:295311.
Stein,JeremyC(1996),Rationalcapitalbudgetinginanirrationalworld,JournalofBusiness, Globalisationandeconomic
nationalism
69:429455. Colantone,Stanig
Globaltrade:Driversbehind
theslowdown
Aslam,Boz,Cerutti,
PoplawskiRibeiro,Topalova
3 A A Viewsonindustrialstrategy
fromeconomists
denHaan,Ellison,Ilzetzki,
McMahon,Reis
Topics:Microeconomicregulation
Understandingthelongrun
effectsofAfricasslave
Tags:emergingmarkets,corporategovernance,Minorityshareholders
trades
Nunn
20,827reads
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