Corporate Equity Ownership and the Governance of Product Market Relationships

Abstract

We assemble a sample of over 10,000 customer-supplier relationships and determine whether the customer owns equity in the supplier. We find that factors related to both contractual incompleteness and financial market frictions are important in the decision of a customer firm to take an equity stake in their supplier. Evidence on the variation in the size of observed equity positions suggests that there are limits to the size of optimal ownership stakes in many relationships. Finally, we find that relationships accompanied by equity ownership last significantly longer than other relationships, suggesting that ownership aids in bonding trading parties together. Copyright 2006 by The American Finance Association.

Large Shareholders and Corporate Policies

“…For activists and pension funds we find significant blockholder fixed effects in investment, financial, and executive compensation policies, but not in operational policies. In contrast, for corporations, we find significant effects in operational policies like R&D policy and in financial policies, e.g., debt ratios, possibly reflecting the fact that many of the corporate blockholdings are due to customer-supplier and other product market relationships (e.g., Allen and Phillips (2000) and Fee, Hadlock, and Thomas (2006)). …”

The impacts of parent’s listing status on subsidiary’s financial constraint and cost of equity capital: the case of equity carve‐outs

“…This indicates that R&D‐intensive firms are subject to financial constraint, which is more severe if firms are affiliated with unlisted parents. The finding echoes Fee et al. ’s (2006) result that in a buyer–supplier relationship, the buyer is more likely to hold an equity stake of the supplier if the supplier is more R&D intensive, because R&D activities are vulnerable to contractual frictions. To confirm the above conclusion, the sample carve‐outs are partitioned into two groups: technological firms and non‐technological firms, because technological firms are generally perceived to be more R&D intensive.…”

“…This indicates that R&D‐intensive firms are subject to financial constraint, which is more severe if firms are affiliated with unlisted parents. The finding echoes Fee et al. ’s (2006) result that in a buyer–supplier relationship, the buyer is more likely to hold an equity stake of the supplier if the supplier is more R&D intensive, because R&D activities are vulnerable to contractual frictions.…”

“…First, technological firms are generally more financially constrained than non‐technological firms because they require more capital for investments, especially the R&D, but they are usually less profitable. Second, high‐R&D firms are prone to monitoring problems and contractual frictions (Fee et al. , 2006), and therefore the property rights of the shareholders of such firms are less protected.…”

“…Shin and Stulz (1998) find that capital investment by a segment of a diversified firm depends on other segments’ cash flows. Allen and Phillips (2000) and Fee et al. (2006) show that the existence of a product–market relationship between two firms might cause one to hold a block ownership of the other to resolve contracting problems.…”