Acknowledgement
Executive Summary
The relationship between ownership structure and firm performance has gained substantial attention of in the finance literature. The present study investigates the ownership structure of firms as a corporate mechanism and its impact on firm’s performance. An empirical analysis of the firms listed on NYSE and NASDAQ belonging to different sectors has been conducted to investigate the relationship between ownership structure and firms performance. The objective of the research is to identify how the corporate governance and corporate identity influence firm’s performance on the basis of three research questions provided in the following.
- How does the corporate governance define the ownership of the firm?
- What is the relationship between corporate identity and financial performance of US firms?
- What is the relationship between the corporate ownership and financial performance of US firms?
The research is significant to understand how the governance practices of the firms shape its ownership structure and its influence on firm’s performance. It provides understanding about contribution of different corporate identities and ownership on shareholder's returns and firm value.
Quantitative research methodology has been adopted to conduct the study. The data has been collected from the various United States firms listed in the NYSE and NASDAQ. The data has been collected from the secondary sources using published financial websites and databases, academic journals, academic databases, periodicals, etc. Moreover, different firms have been selected from the various sectors using random sampling. The researcher has ensured that the information has been gathered from reliable and valid sources.
Cross-sectional analysis has been conducted to identify the relationship between Ownership structure and firms performance. In addition, regression multiple analysis is performed to investigate the relationship between the ownership (corporate identity and corporate structure) on the firms performance (ROA, ROE and Tobin’s Q). The output of the multiple variate regression is in relation to the following four hypotheses:
H1: Firms’ performance is positively influenced by % of outstanding shares held by 5 largest shareholders
H2: Firms’ performance is positively influenced by % of shares held by investment companies or institutional investors
H3: Firms’ performance is positively influenced by % of total outstanding shares held by insiders
H4: Firms’ performance is positively influenced by % of shares held by pension and fund managers
Moreover, descriptive statistics has been used to analyze overall trend in the firm, using central tendency, variable dispersion, mean, etc. The independent variable, ownership structure is represented using two independent variables, that is, corporate governance and corporate identity that are also the controlled variables. On the contrary, Returns on Equity, Returns on Asset and Tobin’s Q ratio are independent variables to represent firms performance. In addition, two control variables including company size and growth rate have been used to enhance the role of independent variables for predicting values of dependent variables are included in this study. The calculation has been done using SPSS (Statistical for the Social Science) for statistical testing of data.
The theoretical framework of the study emphasizes on the agency theory to determine the relationship between ownership structure and firms performance. The major topics of the literature review underlay on 1) Two Dimensions of Ownerships, 2) Ownership Identity and Firms Performance and 3) Ownership Concentration and Firms Performance. The theories and concepts have been identified on the basis of published sources.
The findings of the study highlight that the returns on assets were significant (average ROA 10%). Ownership structure greatly influences the returns of the firms the ROE and Tobin’s Qs of the selected companies had an average of 35 percent of outside shares, 70 percent by the pension and fund managers and 79 percent by the outstanding shares by the insiders. However, the variation in the data exists, indicating that the variation in the firm’s performance prevails because of the different ownership structure of the companies belonging from different sectors.
The results of regression analysis show the p value of ROE, Tobin’s Q and ROA is greater than 0.5 indicating insignificant relation between firm value and ownership concentration and identity. In addition, it shall be noted that the performance of the firms has positive impacts on the increase in the share and different type of shares. Tobin’s Q is significantly influenced by outstanding shares of the selected firms. Therefore, the overall conclusion in this regard is that, although positive, there is no considerable impact of ownership identity and control over the financial performance business entities.
The study concluded that ownership identity and concentration are positively associated with the performance of the firm. The statistical findings confirm that the relationship between ownership concentration and identity impacts the financial performance of the selected companies in the United States. In addition, the study reveals that the increase in the shareholding of the major shareholders impact on performance of the firm is favorable. Two of the instance has noted to have negative influence:
Percent of shares held by the investment companies or institutional investors with the return on assets and Tobin’s Q and Percent of the total outstanding share held by insiders with return on equity.
On the basis of the findings of the current study, it is recommended that the business entities should offer considerable portion of their outstanding shares to its major shareholders, institutional investors, insiders and fund manager. It shall allow the firms to increase its returns.
The researchers have made an effort to reduce the possibility of manual errors in the study. Due to lack of time and availability small sample size has been obtained for the large population of the firms operating in United States. The study is favorable to conduct the future research through adding the qualitative dimensions and comparison of firms operating in the different countries.
Chapter 1: Introduction
1.1 Background and context
Ownership structure of the firm is a fundamental aspect of corporate governance to facilitate the efficiency of the firm (Javid 2009). The legal approaches and property right theories illustrate that shareholders are the rightful owners of firms, whereas the agencies theory claims that the management of the organization are the agents of shareholders because management runs the firms on behalf of the shareholders (Alimehmeti & Paletta 2011; Goudarzi & Ramanarayanan 2011; Ryan, William & Theeoblad 2009). The corporate governance policies and regulation have gained attention of the researchers as a component to improve their financial performance. United States practices market based approach or shareholder-oriented approach to corporate governance. It is one of the reasons that the ownership structure prevailing in the United States is compressed, involves high engagement of institutional investors. The corporate board is smaller due to which high portion of the firms member belong are either independent or outsiders, whereas the internal and external aspects of the firm are linked through audit firms. The corporate governance policies prevailing in the United States are reinforced effectively for the development of global standard for good corporate governance. The researchers claim that corporate governance is the dominant component for the effective performance of firm. It clearly distinguishes the ownership structure of the firms by providing clear framework for ethical practices. Corporate Governance defines the roles and responsibilities between the management and shareholder that minimizes principle agent problems and promotes efficient firm performance.
Mainly the conflict between among management and shareholders prevails on the basis of their interests. Ownership structure and firm performance have been extensively researched to determine the relation between shareholder-manager conflicts. Voniea & Filip (2011) highlights “different ownership structure and role of the people in the organization are the reason for the divergence of interest between the owners and managers” (Voinea & Filip 2011).
Some of the researchers claim that the low-level ownership of insiders has a positive impact on the financial performance on the firm, supporting convergence-of-interest hypothesis (Sutheebanjard & Premchaiswadi 2010). In a similar manner, several other researchers’ state that there is non-linear relation exists between the ownership and financial structure. However, some of the researchers claim that there should be no relation between inside ownership and financial performance (Sutheebanjard & Premchaiswadi 2010). The argument was supported on the views that the firms with effective competitive capital are inclined towards value maximization of the ownership structure (Javid 2009). In addition, it was claims that the inside ownership cannot be a determinant of the financial performance as the insider ownership is endogenously determined.
The conflicts and issues between the relationship of inside and financial performance can arise because of the characteristic of the company. Therefore, it shall be derived from findings of the studies that the ownership-financial performance relation is far from being conclusive. The problem that US-based firms often experience is effectively balancing the duties of protecting shareholders’ interests in a competitive environment while simultaneously upholding managerial accountability to achieve good company performance through monitoring mechanisms, such as a board structure (Fauzi & Locke 2012, p. 44). Other monitoring mechanisms, which should be considered as agents in resolve conflicts between shareholders and managers include the following: capital structure, insider ownership, and block ownership.
Voinea & Filip (2011) argues that emergence of agency problems remains one of the major issues that greatly affects financial performance of the firm (Voinea & Filip 2011). The conflicting interest of the both parties can only be controlled through understanding the ownership structure and required degree of control and location of control.
Corporate governance studies agency issues and ensures that the returns to the shareholder are optimum. Therefore, the management shall consider the discretion of the issues prevailing in the US listed firms. Hence, the corporate governance issues shall not be limited to study maximization of shareholder returns but it shall also take under account that the supplier of the fund gets appropriate portion of the returns on their investment. Herein, Javid (2009) states the agency problems can be overcome only if he ownership (shareholders) is separated from the control (managers) (Javid 2009).
Some of the researchers argue that the main reason for the emergence of agency problems is the distribution of returns between block shareholders and minority shareholders. Hoggett et al. (2012) stated that blocked shareholders have higher benefits than the minor shareholders as they have the privilege of private benefits at the expense of minority shareholders (Goudarzi & Ramanarayanan 2011). One of the reason claims by Hoggett et al. (2012) is that the block shareholders acquire higher benefits because of the pyramidal business structure and cross-holdings across different companies (Hoggett et al. 2012). The difference in identities of shareholders has been identified one of the significant determinants for the companies.
Despite the fact, United States has been criticized for its world’s largest corporate governance scandals. United States Corporate governance policies and standards are known for its overall good performance around the world. The ownership structure under the United States Corporate Governance is not static and has been changed continuously time to time. The present dissertation aims to determine the relationship between ownership structure and corporate governance in United States affects firm’s performance.
- Research Aim
Based on the background and context for the study, it is clear that the current research has an underlying aim to investigate the relationship between the ownership and financial performance. The main objective of this research is to investigate how the corporate identity and corporate ownership of the US listed companies affect their financial performance. To determine how managers can best align themselves with shareholders’ interests so as to create a “trade-off between risk and incentive efficiency."
1.3 Research Objectives
The section illustrates research objectives of the present study. The researcher has focused on the following research objectives to conduct the study:
- The ownership structure prevailing in United States
1.4 Research Questions
Considering the research aim presented in the previous section of the company the following research question have been presented in this study as following:
- How does the corporate governance define the ownership of the firm?
- What is the relationship between corporate identity and financial performance of US companies?
- What is the relationship between corporate ownership and financial performance of US companies?
1.5 Significance of Research
The research determines the influence of ownership structure on the financial performance of firms illustrating corporate governance practices of the company. The different corporate identities and ownership influences the returns to the shareholders and principle-agent relation. It is important to understand how the corporate identities and ownership of the company affects performance of the firm. Therefore, the present study shall provide understanding about how governance practices contribute to structure ownership of firms.
1.6 Scope of Research
The scope of the research is limited to the study of the relationship in companies listed on NYSE and NASDAQ index, which implies that the findings obtained shall be projected over ownership structure and financial performance of the companies in United States.
1.7 Structure of the Report
Chapter 2: Literature Review
2.1 Introduction
This chapter examines the relationship of ownership structure with company’s performances in the light of theoretical and conceptual framework. The theories and concepts are identified from published sources i.e. peer reviewed journal articles and books. In the first part of the literature review, different theories and studies related to ownership identity and company’s performances are examined. The second part of the literature review would provide studies related to ownership concentration with the company’s performances.
2.1 Relationship of Ownership Structure with Company’s Performance
There is a body of literature supporting the argument that ownership structure has a positive impact on a firm’s profitability and/ or performance (Alimehmeti & Paletta 2012, p. 20). However, there are contradictions as well. In order to understand the relationships of ownership structure with company’s performance the following studies are being scrutinized.
- 2.1.1 Agency Theory
According to Shleifer (1986), the literature of agency theory suggests that shareholders are associated as homogenous groups and they have a certain amount of influence on the financial performance of any company, which may be directly proportional to the amount of equity they have. However, there are many contradictions as other scholars like Kang (1999) argue that the shareholders can be heterogeneous as they may have different identities. There are three aspects that enable a shareholder get power for ownership which are formal authority, level of social influence and having specialized skills (expertise).
Many scholars posit based on the principles of the agency theory separation between ownership, and managerial control is needed to ensure product diversification (Alimehmeti & Paletta 2012, p. 40). It is the case since managers desire to acquire benefits related to risk reduction (Alimehmeti & Paletta 2012, p. 40). In an institutional environment where a large group of shareholders are unable to oversee all the activities of management properly, the management is given more freedom in its use of the company’s resources when compared to the institutional environment where ownership is more concentrated (Alimehmeti & Paletta 2012, p. 40).
The institutional environment created by the introduction of the Sarbanes-Oxley Act allowed the ownership structure of US listed companies to have a more dispersed ownership structure as indicated by Fauzi and Locke (2012, p. 44).
Fauzi and Locke (2012) explain that in the US prevent banks, pension funds, mutual funds and insurance companies from having controlling stakes in firms so as to ensure asset diversification. Consequently, minority shareholders’ interests are protected in this institutional arrangement through regulations pertaining to information disclosure, insider- trading, and minority shareholder rights (Fauzi & Locke 2012, p. 44).
However, there are those who contend that controlling mechanisms need to be implemented to align shareholders’ interests with those of the managers. A large group of shareholders may see the need to persuade managers to align themselves with their aim of increasing the value of their shares (Alimehmeti & Paletta 2012, p. 41). Hence, the significance of the boardroom structure in a corporation. Some of the duties of the board of directors include hiring and firing of management (Fauzi & Locke 2012, p. 44), monitoring of management to alleviate agency costs (Fauzi & Locke 2012, p. 44), providing strategic guidance for the company (Fauzi & Locke 2012, p. 44), and providing and giving access to resources (Fauzi & Locke 2012, p. 44). Some scholars assert that a sound corporate governance framework will benefit the company significantly from easier financing, lower costs of capital, improved stakeholder favor and a general improved company performance (Fauzi & Locke 2012, p. 44).
2.2 Two Dimensions of Ownerships
Shareholder's nature to make any decision and exercise power depends on the level of ownership. Thus, in this regard it is important to examine the two dimensions of ownerships (Mintzberg 1983).
Ownership Concentration and Financial Performance
The first dimension of ownership is concentration, and the second dimension is involvement (Mintzberg 1983). Concentration is how the company is being held which could be wither closely or a little widely and involvement shows if the ownership has the means to take influencing decisions with this respect. There are four different types of corporate ownership, which are dispersed detached, dispersed involved, and concentrated detached and concentrated-involved. The concentration levels and identities show the extent to which they can use the power to monitor the activities of the managers and the company. Thus, shareholders have the means to use either one of the power, which can be formal authority social influence or expertise to determine how involved they are which can give different results.
It is important to state that McConnell and Servaes (1990) contributed to the early literature examining the relationship of ownership structure with company performances using Tobin’s Q as an indicator and found that the relationship between Tobin’s Q and shared owned by insiders was curvilinear. It demonstrated that it was important to have a point where ownership could have maximum corporate value.
Hill and Snell (1989) conducted similar studies on the subject and they found out that there was no substantial correlation of Q and the block shareholder which implied that the value of the firm is basically acting as a function of ownership structure based on ownership identity and ownership concentration.
Wolfe (2003) has the view that the relationship of the performance of any enterprise and using Tobin’s Q to measure it provides inconclusive feedback. It is noted that if any under-investment is carried out, the company is bound to perform badly, but it shall always show an increase in Tobin’s Q. In other words, the study showed that underinvestment consequently inflates Tobin’s Q, which makes the performance measure not a very good indicator of firm’s performance (Wolfe & Aidar Sauaia 2003).
Himmelberg (1999) conducted a study using ROA and found that ownership structure has an impact on company’s performance. It can be said that through this calculation company would know how they are increasing their return on assets, either by increasing profitability margins or if their assets are being utilized more so that there are more sales and better performances.
There are some conflicts as it is seen that some investors are not willing to accept that the ROA is the ideal ratio to find out if they have made a good decision to invest in the business. As the return numerator of net income may show suspicion for a fact to be accrual-based earnings, and there can be inadequacies associated with managed earning as well (McClure 2004).
While comparing performances of different firms or determining how much productivity they are generating it may not always provide an accurate picture as return on assets neglects intangible assets like ideas, manpower and innovation but they only look at fixed assets. Thus, it can be said that they may not always indicate the true picture. However, it is also seen that for a long-term analysis ROA provides an understanding of capability leverage options, which drives individuals towards economic retrieval and upturn.
Many scholars like Finch (2006) use return on assets to examine the relationship of ownership structure and company’s performance as they feel that it provides a better measurement metric as compared to income statement measure like determining profits using a metric of “return on sales.” As a return on assets support all the activities that are taking place within the business, therefore, it is easy to find out of these assets are being utilized in an effective way while return on sales can sometimes be just artificially placed to show their robust. Companies that rely on assets need an increased amount of support. The net income should be high so that they are able to support the business practice and consequently they are able to generate a good return on assets even if they have a thin margin.
Sometimes, companies may not utilize the assets themselves instead they may outsource their manufacturing and operations departments to other companies who are having a specialized field so that they can create “asset light” business. The activity to outsource the assets does not indicate the assets have gone rather they are just transferred to another company. The other company is supposed to earn a reasonable return on the assets that are invested by the primary company. It is important to note that many asset light companies contain few or limited current as well as fixed assets that help them in supporting their businesses.
Similar studies conducted by Demsetz (2001) indicate that the ROA metric used to measure performances of the company makes the company focus on assets. In this regard, research indicates that many firms are now outsourcing their assets. During economic crises it is seen the financial leverage makes the company difficult to carry out their operations effectively so an alternate tool, capability leverage can be used. Capability tool is easily used at the time of recession and in this regard, outsourcing companies have the means to provide capable assets and key operations at this time.
Sometimes financial leverage leads the company to neglect the prospective of capability leverage.
When any company is focused on long-term ROA, they utilize the option of capability leverage. ROA has the advantage to measure business operations as well and management may take important decisions taking ROA as the main function. Primarily, ROA does not give good results if resources do not yield good values so decision makers shall always take steps to make sure that the value always tends to increase.
A study by Chaganto and Damanpour (1991) showed that there were more ROEs if there were more proportions of institutional investors. Another study conducted by Haris and Robinson (2003) indicated that if there were more foreign owners there was more productivity. A study conducted by Wet (2007) on the relationship of ownership structure on employee performances using ROE shows that the return on equity is one of the popular sources to find out the financial performance of companies. Its focus is on the return to shareholders and shareholders can easily use this metric to estimate the returns but it is flawed, as well.
It is indicated that the ratio may face many problems, for instance, the management may use wrong means to show high returns on equity while the business practice itself deteriorates. In this regard, economists feel that debt leverage and stocks buy packs can enable companies to sustain a return on equity ratio at times when a company is not able to retain ongoing profits. Thus, it is important that there is competitive pressure, and low-interest rates are applied so it can act as an incentive making investors feel somewhat satisfied. At the same time, if there is excessive debt leverage it can create a kind of a barrier for the company to sustain themselves when the market demand becomes less during recession and economic downturn. As a result, it gives rise to additional risk for the company (Wet 2007).
It is indicated by Wet (2007) that if profitability becomes less and deteriorates with time then efforts taken by management tend to make things worse as they would take more stock paybacks and debt leverage so that the return on equity is maintained which can make the company face further downturns as the consumer demand becomes less. However, if the ROE declines, it affects the stock performance, which will be immediately felt by the company so the other risks are comparatively better as the company may be able to avoid immediate risks.
Even though, none of the metric is perfect but many economists feel that there is over-reliance on ROE, and this becomes problematic at different levels. However, return on assets may provide better indicators and show asset utilization. At the time of economic crises, it is important to know which assets are providing utmost benefits and if other firms are capable of managing all the assets of the company.
It is indicated by Moles (2011, p. 140) ROE is a performance measure widely used for shareholders as they want to know how much profit they are generating when they have invested in the market. In other ways, they get a shorthanded and consolidated result of their investment prospects having one shortfall. They do not provide a comprehensive understanding of the performance of any company like if the company is taking too much debt it would not show in the leverage as mentioned.
With respect to institutional investors, Chaganti and Damanpour (1991) conducted a research and found that if there were more institutional investors then it would indicate there are higher ROE. This study shows that ROE as a metric can be successful to determine the relationship of ownership structure with firms performances.
2.2.2 Ownership Identity and Financial Performance
Many scholars like Herman (1981) and Sorenson (1996) conducted study to understand the difference between owners controlled companies and companies that are controlled by managers and it was proved that the problems occurring in the owner controlled companies could be reduced if the agents were giving shares in the company. On the other hand, Morck and Vishny (1988) suggested that structure of organizations with respect to ownership identity and different roles of people has made organizations establish a kind of information asymmetry. The differences are basically arising due varied interests of the owners and the management. Thus, it has is claimed that investigations are needed to examine about the problems existing between the principal and the agent as it important to see if the problems can be alleviated by giving them some share in ownership.
It is argued by Ben-Amar (2006) that reduction or elimination of costs of agencies is only possible where it is easier to disperse the ownership. As there are many different types of ownership like institutional investors, corporate or government investors thus in order to determine their level of involvement, it would depend on the type and nature of ownership they are having.
Elayan, Lau & Myer (2003) conducted a research and found out that there is a progressive linear relationship existing between ownership and financial performances if there is few levels of insider ownership provided they are supporting the convergence of interest hypothesis.
Chen (1993) reported that the underlying relationship between insider ownership and financial performances of the companies might not reduce the consequences even if there was any reasoning, making it non-monotonic. Many scholars like Demsetz& Lehn (2001) have the view that financial performances and insider ownership has no relationship at all. They based their judgment on the fact most of the companies working with high capital have the means to choose an ownership structure which is focused on value maximization.
According to some scholars the agency problem is present amongst block shareholders and minority shareholders as the block shareholders get more benefits through a business structure which works in a pyramidal way, and having association with cross-holdings across different firms. In this regard, Cubbin (1983) states that the control levels and location to find out the identity of the investor is an important part of ownership-performance relationship.
As mentioned by Kang (1999), shareholders belong to different heterogeneous groups so they gain power as a result of their identities to achieve their desired goals. Short (1994) has the view that the relationships of ownership-performances are different due to differences in the levels of the ownership.
According to Anderson & Reeb (2003) employee (insider) shares are mostly held by the management or other staff and their power depends upon how much influential they are in the company which gives them the authority to exercise control in the company. If there is more involvement the agency costs may become less but the managers may still get the opportunity to gain control. It also provides opportunities for other employees to get promoted and be placed in different management positions (Anderson & Reeb 2003).
Foreign shareholders (FH) are held by the foreign investor and the government or the state that have the involvement ownership as they not holds the government share only exercise power on the property but they also have the role to regulate state policy. With respect to agency problems many scholars like Boycko (1996) argue that the issues only arise due to political issues and are not linked with the management as the state or government bodies are more interested in getting political gain or benefits rather than to get any financial returns.
Corporate Shares (CH) is the kind of legal share which are basically held by another company and rely on company’s performances whether they are long term or short. Institutional shares (IH) on the other hand are also a kind of a legal share, which are only concerned with the long-term returns as an investment bank mostly holds them and they do not seek information regarding day-to-day returns. Hence, it can be said that Corporate Shares are mostly involved than their latter.
Nickel, Nicolitsas and Dryden (1997) conducted similar researches to understand the relationship of the different types of ownerships and compared them with the performances of the company. If other factors like competition in market, pressure and shareholders control was kept aside or controlled, it was noted that only one kind of external shareholders had an impact on the company’s productivity which are financial institutions (Nickel, Nicolitsas & Dryden 1997).
Sarbanes-Oxley Act, which was introduced in the US, helps in promoting transparency as it pertains to the ownership structure of US listed firms (Fauzi& Locke 2012, p. 44). Hence, determining the identity of owners is not a problematic endeavor when assessing the institutional environment of the US. This legislation also ensures that even minority shareholders are protected Nevertheless, Thomsen and Pedersen (1997) took care to indicate that this was a unique institutional arrangement (p. 1).
In addition, according to Cucculelli (2009), different ultimate owners may have an impact on a company’s performance, especially as it pertains to facing risk (p. 4). It was discovered in the study that younger generations will bring “fresh knowledge and strategic renewal” while older family-owned firms will ensure higher growth rates of sales when compared to their younger counterparts (Cucculelli 2009, p. 6). Moreover, it was discovered that an active family control improves the performance of older companies (Cucculelli 2009, p. 6). Conversely, the issue of life cycle, along with the family orientation of newer generations, supports the theory of a lower growth in older firms compared with younger companies (Cucculelli 2009, p. 6).
Furthermore, as mentioned before, that many scholars believed that ownership identity was homogenous (Reddi, Abidin & & He 2010, p. 4). However, it was later revealed that ownership identity couldn’t be homogenous when they have different identities (Reddi, Abidin, He 2010, p. 4). To support this, there is a significant body of literature which indicates that shareholders can use their identity to acquire powers to enable them to control companies in a manner that lead to extracting private benefits (Reddi, Abidin, He 2010, p. 4).
Varcholova and Beslerova (2013) conducted a study relating to ownership identity and performances of companies and findings of research indicated that enterprises, which were primarily state owned, performed better than others. Additionally, another study by Goethals and Ooghe (1997) showed that foreign companies also performed better than the local companies due to the structure of ownership identity.
While ownership identities have means to deal with the market, thus few economists like Verneulen (2012) has the view that it is important that there is adequate disclosure of ownership identity so that that can be monitored and it is ensured that they are dealing honestly with regard to pricing of securities. Moreover, it is important there is data to exercise a certain amount of control over shareholding structure and voting rights so that they are properly regulated.
Dybvig and Warachka (2012) have the view that Tobin's Q ratio may not indicate how a company performs. They based their judgment on the fact that when a company with market value of $15 starts a new project and if they require about $20 then it means that their market value is increasing to $ 24 but the Tobin’s Q ratio will be seen decreasing to 1.3 rather than increasing. However, Wenerfelt (1988) has a different perspective as they say there are certain “industry effects” which may be known as the primary determinants of a company to become successful using Tobin’s Q ratio, which is measuring the performances (Wernerfelt & Montgomery 1988).
While any ownership structure is being examined, this market measure or indicator Tobin’s Q is used to test the market value of any company.
Wenerfelt& Montgomery (1988) conducted a study to measure relationship of ownership structure with performances by using Tobin’s Q and according it is important to understand and comprehend how the ownerships structure is having an impact on firm’s production. In this regard, it is important to see what managers has already achieved and what they will achieve. Moreover, in order to assess performances it is important to determine the level of constrained factors like their acumen and level of optimism as well as pessimism. Thus, Wenerfelt has the view they are market constraints rather than accounting constraints hence favor the Q. However, it is important to be cautious of the fact that the profits are not associated with these elements of psychological states rather it depends on the future events like goodwill and depreciation. Tobin’s Q is carried out by the investor to determine the forecasts of the present business and the strategies that are taken with regard to events taking place in the world at the time when businesses are being practiced (Wernerfelt & Montgomery 1988).
Demsetz (2001) conducted similar studies using Tobin’s Q and according to him all accounting profits are affected by the practices within the accounting field like tangible and intangible capital so Tobin’s Q is always affected severely. It is necessary to note that the numerator of Q shows what intangible assets are being assigned by the investor but in the dominator where there are replacement costs of tangible assets but it does not show investments that are made in the intangible assets. Thus, there are distortions while comparing performance of firms especially with regard to intangible capital (Weiss 1969; Telser 1969).
Studies conducted by McConnell and Servaes (McConnell & Servaes 1990) indicate that q ratio does not have linear relationship with insider relationship. These studies support the view that the insider’s ownership may have a negative relationship with corporate performances. However, q ratio mostly has a positive correlation with the institutional ownership (McConnell & Servaes 1990). McConnell and Servares (1990) believe that it would be more difficult to get managers to entrench in this case when there are institutional shareholders.
Ownership Concentration and Company Performance
Hill and Snell (1989) have the view that diversification, investment, and ownership structure (concentration and identity) have an impact on a company’s performance. However, if the shareholders control is concentrated it will have a negative impact on product diversification. However, a contradictory study said by Shleifer and Vhishny (1997) said concentrated and larger shareholders might be able to exercise more control, which can increase the value of the share. Another study by Fama and Jensen (1983) indicate that ownership concentration can make the management become entrenched which is a negative impact and as a result they may even in other ways take the wealth away from other minority shareholders. Similar studies by La Porta (1999) note the same that if there is an emphasis of the agency problem and concentration raises the power shall remain on these shareholders and minority shareholders would bear the brunt as their value would be expropriated. These problems are mostly noted in European countries.
According to Grant and Kirchmaier (2004), a concentrated ownership structure can monitor management more effectively which can make the performances of the company better but as mentioned before this can prove unsuitable for minority shareholders.
