Going Public without Governance: Managerial Reputation Effects

Abstract

This paper addresses the agency problem between controlling shareholders and minority shareholders. This problem is common among public firms in many countries where the legal system does not effectively protect minority shareholders against oppression by controlling shareholders. We show that even without any explicit corporate governance mechanisms protecting minority shareholders, controlling shareholders can implicitly commit not to expropriate them. Stock prices of such companies are significantly higher and firms are more likely go public because of this reputation effect. Moreover, insiders divest shares gradually over time, at a rate that is negatively related to the degree of moral hazard.RECENT EMPIRICAL RESEARCH INDICATES THAT in many countries the relevant corporate finance issue is not the traditional agency problem between management and shareholders, but rather the agency problem between the controlling shareholders and the minority shareholders. This problem may arise in some countries for two reasons:~1! the corporate governance structure of public companies insulates large shareholders-that is, those with a majority of the votes and often with an involvement in the firm's management-from takeover threats or monitoring; 1 and~2! the legal system does not protect minority shareholders because of either poor laws or poor enforcement of laws. 2 Despite the lack of protection for minority shareholders, the average ratio of stock market capitalization held by minorities to gross national product is greater than 40 percent in a sample of 49 countries. 3 This raises the question of why people are willing to be minority shareholders when they know * The Wharton School, University of Pennsylvania. Financial support from CAPES, Brazil, is gratefully acknowledged. I wish to thank Andrei Shleifer and Oliver Hart for their many invaluable suggestions and encouragement in pursuing this work. I am also grateful for helpful comments from the editor and two anonymous referees. I also thank

Controlling shareholders and corporate value: Evidence from Thailand

“…This phenomenon is indeed consistent with the hypothesis of Gomes (2000). He contends that in choosing the optimal levels of ownership structure before the IPO , owners maximize their net private benefits of control and their shares of the cash flows.…”

“…Bebchuk (1999b) argues that publicly traded companies in countries where private benefits of control are large, or the degree of the agency costs is high, are likely to have a controlling shareholder. Similar to the alignment effect hypothesized by Jensen and Meckling (1976), Gomes (2000) and Bennedsen and Wolfenzon (2000) describe that by holding a large ownership stake, the controlling shareholder internalizes private benefits he extracts, and hence the expropriation costs are reduced.…”

“…La Porta et al (1999), Bebchuk (1999b), and Gomes (2000) argue that in the countries when the legal and institutional frameworks do not offer sufficient protection for outside investors, concentrated ownership can mitigate the shareholder conflicts. Gomes (2000) contends that in this kind of environment the only equilibrium is to have controlling shareholders. The basic intuition is that large ownership stakes provide a commitment signal to outside investors that the controlling shareholders would not divert corporate assets.…”

Creditor rights, culture and dividend payout policy

“…The notion that dividends can curb agency costs of equity is not new (see for example, Rozeff, 1982;Easterbrook, 1984;Jensen, 1986;Lang and Litzenberger, 1989;and Gomes, 2000, to name but a few). La Porta et al (2000) formulate two competing, but not mutually-exclusive, agency theories of dividend payout, namely the outcome and substitution models.…”

The Budget Constraint in the Governance of Organizations

“…18 Under this paradigm (compared to the shareholder value paradigm) there will be an alloca- persed on these liquid markets and the system can be efficacious.…”