Academic journal article Quarterly Journal of Business and Economics

Ownership Structure and Risk: A Canadian Empirical Analysis

Academic journal article Quarterly Journal of Business and Economics

Ownership Structure and Risk: A Canadian Empirical Analysis

Article excerpt

Introduction

Most previous studies on corporate governance and ownership structure examine the problem of separation between ownership and management (e.g., Jensen and Meckling, 1976; Fama and Jensen, 1983a, 1983b). In particular, they relate the relationship between the ownership concentration and other variables such as firm performance (e.g., Morck, Shleifer, and Vishny, 1988), value (e.g., Slovin and Sushka, 1993), competitiveness (e.g., Gadhoum, 1999), and its usual financial decisions or policies (e.g., Stulz, 1988). Surprisingly, one issue has received little attention: the influence of corporate ownership on the risk-taking behavior of non-financial firms. Previous studies have failed to explicitly account for the potential association between measures of ownership dispersion and the firm's underlying risk exposure. Some studies, however, indicate a possible link between these two variables (e.g., Galai and Masulis, 1976; Smith and Stulz, 1985; Aggrawal and Mandelker, 1987). They show that when ownership is diffuse, for example, firm managers may tend to pursue strategies that do not maximize the wealth of shareholders. Such behavior eventually will impact the firm's operating risk (through the inefficient use of resources) as well as its financial risk exposure, given sub-optimal investments are made.

It is worth noting that the link between ownership structure and firm risk-taking was first evoked by Berle and Means (1932) and theorized by Monsen and Downs (1965) and Monsen et al. (1968). They argue that ownership-management separation leaves room for conflicting goals between owners and managers to arise because of the asymmetry between risk-taking and rewards. This asymmetry appears to take the form of greater incentives and expectation of rewards for the owners than for the managers in terms of risk-taking. Managers will opt to invest in less risky projects to protect their invested non-diversifiable human capital in the firm. Conversely, owners favor more risky projects to maximize the call option value embedded in their equity holding. Hence, it can be argued that the nature of and changes in corporate governance have potential implications for the firm's riskiness (1). Such relationship is potentially valuable internally for firm managers and shareholders. It is even more useful externally for the active portfolio manager who adjusts his or her risk exposure to changes in the firm's risk-taking behavior in order to optimize his or her hedging related activities.

Despite the obvious importance of agency costs and their effect on firm risk-taking, little is known about the influence of managers and insiders on corporate risk-taking. To the best of our knowledge, only a few papers have directly addressed this issue for non-financial firms (e.g., Amihud and Lev, 1981; Chen and Steiner, 1999; Wright et al., 1999). We do note extensive research on this topic for financial firms such as banks (e.g., Saunders et al. 1990; Demsetz et al., 1997; Anderson and Fraser, 2000), depository institutions (e.g., Chen et al., 1998), savings and loans (S&Ls, e.g., Cebenoyan et al. 1995), thrifts (e.g., Cebenoyan et al., 1999), and insurance companies (e.g., Joan and Starks, 1993). Most of these papers have focused on the impact of management equity stakes on the performance and risk of the institution. In this context, this paper complements previous research in the U.S. It seeks to provide a comprehensive analysis of the relationship between the ownership structure of non-financial Canadian firms and their underlying risk exposure, using different measures for both variables and controlling for their common variation under several specifications. Our investigation is interesting, given that ownership structure is concentrated in Canada whereas it is proven that U.S. firms are widely held. (2) The current research provides direct empirical evidence of the relationship between risk and ownership concentration variables by applying univariate and multivariate frameworks to Canadian data. …

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