Academic journal article International Journal of Business

Changes in Block Ownership in the London Stock Exchange

Academic journal article International Journal of Business

Changes in Block Ownership in the London Stock Exchange

Article excerpt

ABSTRACT

We analyze the time-series distribution of large blockholders and managerial ownership in the UK over the last decade. We find a significant decrease in the size of block ownership of a large number of companies. We show that the increase in firm's size and risk and the decrease in performance explain a large proportion of this change. We also find that the dilution of ownership through new issues rather than sales of stakes are the main reasons for the decrease in management ownership and the holdings of pressure-resistant investors, such as fund managers and pension funds. Overall, our results are consistent with the contractual hypothesis as companies appear to consider ownership by different categories as substitute means of resolving agency conflicts.

JEL Classification: G30, G32, G34

Keywords: Corporate governance; Ownership structure; Managerial ownership

I. INTRODUCTION

Share ownership by institutional investors has been in the centre of much debate, criticism and reviews. In theory, block ownership by institutional investors should prevent managers from pursuing their own interest at the expense of those of shareholders. This divergence of interest between managers and shareholders, referred to in the literature as the agency conflict, cannot be totally resolved by the market for corporate control (Jensen 1993), legal rules (e.g., Shleifer and Vishny, 1997) or by managerial holding (e.g., McConnell and Servaes, 1990, 1995). (1) Instead, some other additional mechanisms, such as block ownership by institutional investors, are likely to solve these agency problems (e.g., Agrawal and Knoeber, 1996) when their monitoring benefits outweigh the costs.

The empirical evidence provided to date on the effectiveness and efficiency of the monitoring role of blockholders is mixed. In an extensive survey on the monitoring role of blockholders, Holderness (2003) shows that, on average, blockholders own about 20% of US equities, and enjoy both the shared and the private benefits of control. In the UK, Faccio and Lasfer (2000) report that companies in which pension funds, the largest shareholder category, do not over-perform. However, most studies in the area are based on only one year data while the link between ownership and control is likely to be time-dependant. The purpose of this paper is to overcome this limitation and contribute to the previous literature by documenting the reasons for changes in the firms' ownership structure, assessing whether these changes are driven by changes in the firms' fundamental factors and whether companies have moved into a more appropriate optimal level of ownership structure in the late 1990s.

The answers to these questions are especially relevant for individual investors and policy-makers who rely on large blockholders to monitor companies. For example, in the UK, large investors, which are mainly institutional investors, are perceived as carrying a social responsibility of promoting good corporate governance in companies in which they hold shares (Cadbury, 1992). By virtue of their size, they are thought of as equipped with the power to govern by exercising their voting rights.

We identify separately the categories of blockholders reported in the financial statements of each company in the sample. These include insiders, fund managers, pension funds, banks, insurance companies, overseas investors, public companies, individuals and nominees. We classify these into four main categories: (i) Insiders, (ii) minority shareholders which include overseas investors, public companies, individuals and nominees, and we follow Brickley, Lease and Smith (1988, 1994) in classifying the remaining shareholders into (iii) pressure-resistant investors (fund managers and pension funds), and, (iv) pressure-sensitive shareholders (banks and insurance companies, because of potential commercial link with the company). We then analyse the determinants of the changes in ownership structure over the last decade and test the contractual hypothesis under which companies adopt an optimal ownership structure to minimize their potential agency costs. …

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