Academic journal article Risk Management and Insurance Review

Separation of Ownership and Management: Implications for Risk-Taking Behavior

Academic journal article Risk Management and Insurance Review

Separation of Ownership and Management: Implications for Risk-Taking Behavior

Article excerpt

ABSTRACT

Issues associated with the relation between the separation of ownership and management and risk-taking behavior have been considered in an array of studies, with varying results. Due to the wide variety of ownership structures present, the property-casualty insurance industry provides an excellent setting to test the conflicting hypotheses related to separation of ownership from management and risk taking behavior. Employing a large sample of property-liability insurance companies over the period of 1996-2004, we empirically test the alternative hypotheses regarding the implications of separation of ownership from management for firms' risk taking behavior. The empirical tests include the ownership structures specified in prior research as well as a more detailed classification scheme. We find that each ownership structure is significantly different from every other ownership structure in terms of risk.

INTRODUCTION AND MOTIVATION

In general, the insurance industry in the United States is dominated by two ownership structures: mutual companies and stock companies. Stock companies employ the standard corporate form, while mutuals merge the customer and owner functions. However, this simple distinction masks a more complex reality. Within the category of stock insurers, tremendous variation in ownership structure exists. At one extreme, stock ownership can be fully concentrated in the hands of management, and at the other extreme, the stock ownership can be widely dispersed when the stock company is ultimately owned by a mutual parent. These ownership structures manifest various degrees of separation of ownership from management. Specifically, as explained later in the article, the degree of separation of ownership from management increases as one moves across the ownership structures, from companies closely held by management, to companies closely held by others (i.e., parties other than management), to widely held stock insurers, to mutual-owned stock insurers, and finally to mutual insurers.

The prior literature has shown that mutual and stock ownership structures are significantly different from each other and that such differences have important implications for insurers' distribution choices, CEO compensation, and other aspects of insurers' operations (e.g., Mayers and Smith, 1981, 1988, 1992; Kim, Mayers, and Smith, 1996; Pottier and Sommer, 1997; Regan and Tzeng, 1999). The difference between mutual and stock ownership structures also has important implications for insurers' risk-taking behavior, including decisions related to business mix and investment strategies (Lamm-Tennant and Starks, 1993; Lee, Mayers, and Smith, 1997). The results of existing studies are consistent with greater separation of ownership and management being associated with less risk taking.

More than one theory can be found in the existing literature relating to the implications of separation of ownership and management for firms' risk-taking behavior, especially when taking into account the entire spectrum of ownership structures. For example, Cummins and Sommer (1996) argue that risk taking is negatively associated with the degree of separation of ownership and management, implying that risk taking would be lower in widely held companies than in closely held companies. However, Fama and Jensen (1983) predict that firms' risk taking is positively associated with the degree of separation of ownership and management, implying that risk taking is expected to be higher in widely held companies than in closely held companies.

Understanding the relation between ownership and management separation and risktaking behavior is a salient issue for a variety of stakeholders. Not only does it impact both the owners and managers of the firm, but it is also important to policyholders and regulators. The risk-taking behavior of insurance companies affects the price and availability of coverage as well as the solvency of the insurers. …

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