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The effect of large controlling shareholders on equity prices in France: monitoring or entrenchment?

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Abstract

The corporate governance literature has shown that firms with better governance exhibit higher abnormal returns. In this paper, we examine the effect of cash flow concentration and excess control on equity pricing in France, a country with relatively weak protection for investors. Using hand-collected data on publicly-listed French firms over the period from 2002 to 2011, we find that firms, in which controlling shareholders hold a major proportion of cash flow rights, have higher market performance. Cash flow concentration is a useful monitoring tool for firms to address agency problems. In contrast, a higher level of discrepancy between the control and cash-flow rights of the ultimate controlling shareholders is associated with lower market performance. Control-ownership wedge increases the incentive of the controlling shareholders to act corruptly or unethically. These findings support both incentives hypothesis arising from the cash flow concentration and the expropriation effects arising from the excess control rights. These findings have strong implications for market participants and portfolio investment.

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Notes

  1. La Porta et al. (1999) show that more than 60% of large corporations in 27 richest countries have dominant shareholders.

    Several studies document a significant concentration of ownership among the United States (Morck et al. 1988) Holderness et al. 1999), nine East Asian countries (Claessens et al. 2000) 13 Western European countries (Faccio and Lang 2002) and Germany (Franks and Mayer 1995).

  2. A recent study of 464 firms conducted by Institutional Investor Services (2007) in 16 European countries report that the most frequent control-enhancing mechanisms in Europe are pyramids (27% of companies) and dual-class shares (24%). Multiple-voting shares are one of the primary devices used in France (58%) to enhance control. For additional evidence on the prevalence of Ownership disproportionality and the deviations from one share-one vote for Western Europe, see Faccio and Lang (2002).

  3. The first empirical research on the relationship between governance index and equity prices in US was carried out by Gompers et al. (2003). The authors find that an investment strategy that consists of buying well-governed firms and selling poorly-governed yields an abnormal return of around 8.5% per year. After them, this pattern was supported by the findings of Cremers and Nair (2005) and Core et al. (2006) Apart from the US, the positive relationship between corporate governance and firm performance was also reported for Russian (Black 2001); Korean (Black et al. 2006); and German public firms (Drobetz et al. 2004). However, another group of researchers pointed out that this positive relation might not hold. For example, Johnson et al. (2009) show that long-term abnormal stock returns are not affected by the quality of governance and attribute the abnormal return of the hedge portfolio to industry clustering. Cremers and Ferrell (2009) and more recently Bebchuk et al. (2013) documents the disappearance of the governance-return correlation. They provide evidence that the correlation between abnormal returns and corporate governance dos not persist for long term due to the market participants' learning.

  4. For example, Belkhir et al. (2013) report that agency problems between large and minority shareholders increase with the degree of separation of cash-flow and control rights, which reduces a firm's attractiveness to outside investors and encourages the largest controlling shareholders to take their firms private in France. In the same vein, Boubaker et al. (2014), document that shareholder wealth gains from going private increases in firms that exhibits a higher separation of cash-flow and control rights of its ultimate owner.

  5. The use of a 10% voting rights threshold is supported by a substantial body of literature (La Porta et al. (1999); Claessens et al. (2002); Attig et al. (2006)), suggesting that this level is sufficient to exert effective control over a firm.

  6. For additional evidence on the procedure of computing ownership and excess control rights. See Boubaker and Labégorre (2008a) and Boubaker and Labégorre (2009).

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Authors and Affiliations

  1. IHEC, University of Carthage, Carthage, Tunisia

    Zeineb Barka & Taher Hamza

  2. LAMIDED, University of Sousse, Sousse, Tunisia

    Zeineb Barka

  3. VALLOREM Lab, University d’Orléans, Orléans, France

    Taher Hamza

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Barka, Z., Hamza, T. The effect of large controlling shareholders on equity prices in France: monitoring or entrenchment?. J Manag Gov 24, 769–798 (2020). https://doi.org/10.1007/s10997-019-09484-y

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