Global Variations in Ownership Structures

Mismanagement of finite resources and environmental degradation from manufacturing processes can lead to corporate events that negatively impact security prices. Therefore, companies have seen the need to integrate such factors in their investment analysis.

Dispersed vs Concentrated Ownership

Dispersed ownership refers to many shareholders with none having the ability to exercise power over the corporation individually. On the other hand, concentrated ownership refers to individuals or controlling shareholders with the ability to exercise power over the company. The controlling shareholders can be a family, another company, or a sovereign entity in this context. Concentrated ownership structures are more common than dispersed ownership structures.

Horizontal ownerships involve companies with mutual business interests, and this structure can help foster strategic alliances and promote long-term relationships among the companies. Vertical ownership refers to an ownership structure where a group controls shareholders in two or more holding companies controlling interests in various operating companies.

Dual-class shares give a shareholder sole voting rights. With a vertical ownership structure, the company with high controlling interests can issue a large quantity or all dual-class shares to maintain control over operating companies with fewer total shares.

Conflict within Different Ownership Structures

Conflicts arise from the different ownership structures, which in turn affect corporate governance and practices. For example, conflicts can exist among shareholders or between the shareholders and managers. A mix of weak shareholders, who have dispersed voting power and ownership, and strong managers can lead to a principal-agent problem where managers will use company resources to pursue their interests and shareholders are looking to maximize their wealth. To solve this problem, controlling shareholders can step in and use their power to control the board of directors, who monitor management to ensure they act in the company’s best interest.

Another conflict is referred to as the principal-principal problem. This problem occurs when strong shareholders with concentrated ownership and concentrated voting power use their influence and power over the board of directors to monitor and appoint managers. However, the controlling owners can use their concentrated voting power and concentrated ownership to use company resources for their benefit at the expense of minority shareholders.

Principal-principal problems can occur in a mix of dispersed ownership and concentrated voting power. In this situation controlling shareholders, despite less ownership, use their voting power to influence the minority shareholders and monitor management.

A mix of dispersed voting power and concentrated ownership can manifest when a government imposes voting caps to prevent foreign investors from taking over important local companies.

Types of Influential Shareholders

• Banks: Banks have both equity interests and lending relationships with many corporations. The conflict may arise when a bank is a strong shareholder and uses its influence in a corporation to take out a loan with the bank with unfavorable terms at the expense of other shareholders. The best corporate governance practice to control this problem is to ensure that banks that are both investors and lenders balance their interests, first as lenders to the corporation and lastly as shareholders.
• Families: Several corporations worldwide are family-owned, with family members serving on the boards of such companies. The advantage of family control is that it reduces the risk associated with the principal-agent problem because it is responsible for the management and has concentrated ownership. The disadvantage of family ownership is that there may be a shallow talent pool since most employees or managers come from within the family. It also leads to poor transparency and accountability, and little consideration for minority shareholders.
• State-owned enterprises: Many state-owned enterprises (SOE) are strategically important to the government and have an initial capital requirement that the private sector cannot achieve or companies that provide public services (e.g., health care). Several listed SOEs have stocks traded in the stock market and are partially owned by sovereign governments in a mixed-ownership model. The benefit of SEOs is that they have less scrutiny of management from the market. The drawback is that the SOEs may undertake projects contrary to shareholders’ interests but are good for the public.
• Institutional investors: Institutional investors can use informed decisions in executing their shareholder rights due to market expertise and enormous resources. However, in a dispersed ownership market, they do not have enough ownership to become controlling shareholders. An institutional investor can hold a company’s management and board accountable when the board acts contrary to shareholders’ interests. This accountability promotes corporate governance.
• Group companies: These companies have shareholders with higher control relative to ownership. Long-term relationships between group companies prevent the potential transfer of share ownership and are a barrier to outsiders looking to buy many shares. With enough corporate governance policies, the risk of companies controlled by groups engaging in business contrary to minority shareholders is reduced significantly.
• Private equity firms: Private equity companies involved in leveraged buyouts and venture capital are strategic owners who invest in public companies to take them private. Venture capital firms invest in young companies, while leveraged buyout firms have control over more mature companies. In addition, venture capital and leveraged buyout firms may develop corporate codes of conduct as they manage the corporation, promoting corporate governance.
• Foreign investors: Foreign investors from countries with high standards of corporate governance might demand the same from local companies that they investing in. Local shareholders will benefit from the decision of a local company to cross-list its shares in another country with greater transparency and accountability.
• Managers and board directors: Directors and managers who are also investors are known as insiders. As insiders increase their ownership in a company, their interest with outsiders is aligned. As a result, board and management insiders begin to take on more long-term and profitable projects to benefit the company.

Effects of Ownership Structure on Corporate Governance

1. Director Independence

An independent board member is a board of directors who has no direct relationship with the company. The number of independent board members is higher in areas where many companies have dispersed ownership structures. The presence of independent members strengthens corporate governance by monitoring management and the board. In jurisdictions with concentrated ownership structures, independent board members are not mandatory.

2. Board Structures

Board structures can either be one-tier or two-tier. A one-tier board structure is composed of a single board of directors with executive and non-executive members. A two-tier board structure has two boards: the management board and the supervisory board, which oversees the management board. In addition, the supervisory board serves as a control function by auditing and inspecting the corporation’s group.

3. Special Voting Arrangements

Special voting arrangements are put in place in different jurisdictions to improve the position of minority shareholders in board nominations.

4. Corporate Governance Codes, Laws, and Listing Requirements

Several countries have national corporate governance codes where companies must adopt and comply with corporate governance codes. In situations where corporate governance codes are non-existent, company law or stock exchange listing requirements can achieve the same corporate governance codes.

5. Stewardship Codes

Stewardship codes are voluntary codes introduced by a country that encourages investors to use their legal rights as shareholders to increase corporate governance engagement. In some countries like the UK, stewardship codes are mandatory.

Question

Which of the following may arise from a company whose share ownership is dispersed and voting power is also dispersed?

1. The principal-principal problem.
2. The principal-agent problem.
3. The agent-agent problem.

Solution

The correct answer is B.

Dispersed ownership and dispersed power lead to a situation where we have weak shareholders and strong managers, increasing the principal-agent problem.

A is incorrect. This occurs when we have concentrated ownership and concentrated power.

C is incorrect. An agent-agent problem is not mentioned in this reading.

Reading 19: Environmental, Social, and Governance (ESG) Considerations in Investment Analysis

LOS 19 (a) Describe global variations in ownership structures and the possible effects of these variations on corporate governance policies and practices.