Structural models and endogeneity in corporate finance: The link between managerial ownership and corporate performance

Abstract

Abstract:This paper presents a parsimonious, structural model that isolates primary economic determinants of the level and dispersion of managerial ownership, firm scale, and performance and the empirical associations among them. In particular, variation across firms and through time of estimated productivity parameters for physical assets and managerial input and corresponding variation in optimal compensation contract and firm size combine to deliver the well-known hump-shaped relation between Tobin's Q and managerial ownership. To assess the effectiveness of standard econometric approaches to the endogeneity problem, we apply those remedies to panel data generated from the model. The unfortunate conclusion is that, at least in the ownership-performance context, proxy variables, fixed effects, and instrumental variables do not generally provide reliable solutions to simultaneity bias. 2 ABSTRACT This paper presents a parsimonious, structural model that isolates primary economic determinants of the level and dispersion of managerial ownership, firm scale, and performance and the empirical associations among them. In particular, variation across firms and through time of estimated productivity parameters for physical assets and managerial input and corresponding variation in optimal compensation contract and firm size combine to deliver the well-known hump-shaped relation between Tobin's Q and managerial ownership. To assess the effectiveness of standard econometric approaches to the endogeneity problem, we apply those remedies to panel data generated from the model. The unfortunate conclusion is that, at least in the ownership-performance context, proxy variables, fixed effects, and instrumental variables do not generally provide reliable solutions to simultaneity bias.

Corporate governance and cash holdings in MENA: Evidence from internal and external governance practices

“…It is argued in the literature that the endogeneity issue is important in cases where corporate governance is included (see, Coles, et al, 2005). Our IV models control for the endogeneity issue where the instruments include lagged corporate governance variables, lagged leverage, and lagged dividends.…”

The problem of causality in corporate governance research: The case of governance indexes and firm valuation

“…3 In particular, see the opposing results in the literature that examines ownership structure and its relation to firm performance (Demsetz and Lehn, 1985;Mork, Shleifer and Vishny, 1988;Hermalin and Weisbach, 1991;Himmelberg, Hubbard and Palia, 1999;Coles, Lemmon and Meschke, 2012) or the conflicting results other kinds of studies explicitly in this paper, the argument on how to deal with causality discussed below is also applicable to their respective cases.…”

What is the Relation (If Any) between a Firm's Corporate Governance Arrangements and Its Financial Performance?

“…The other causes are omitted variables and measurement errors. For a general treatment of endogeneity, see Roberts and Whited (2012); for critical examination of several commonly applied remedies, see Coles, Lemmon, and Meschke (2012).…”