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Shareholder Expropriation in the U.S.

By Harvard Law School Program on Corporate Governance

(Editor’s Note: This post comes to us from Vladimir Atanasov of the College of William and Mary, Audra Boone of the University of Kansas, and David Haushalter of Pennsylvania State University.)

Contrary to the general view that publicly-traded firms in the United States are diffusely owned, blockholders in these firms are both frequent and substantial. However, despite the prevalence of blockholders, their effect on firm value is unresolved. In our forthcoming Journal of Financial and Quantitative Analysis paper Is there shareholder expropriation in the United States? An analysis of publicly-traded subsidiaries, we seek to fill this void by examining majority and non-majority blockholdings separately, and by examining corporate blockholders exclusively.

Our analysis employs a sample of 264 U.S. subsidiaries that were each separated from their parent corporation via an initial public offering, known as an equity carve-out. We follow the financial performance of these subsidiaries for the four years following the initial carve-out; divide these subsidiaries into three groups based on the fraction of shares owned by the parent firm; and identify annual changes in ownership levels. Our three ownership groups break down as follows: 1) majority-owned subsidiaries in which the parent owns a 50 to 99% stake; 2) minority-owned subsidiaries in which the parent owns a 5 to 49% stake; and 3) completely divested subsidiaries in which the parent owns less than a 5% stake. In order to determine whether subsidiary performance is associated with parent ownership, we focus our empirical tests on the subsidiary’s financial performance and document several key results.

First, we find that subsidiary operating performance varies depending on the parent’s ownership stake. Indeed, while majority-owned and completely-divested subsidiaries experience normal performance, minority-owned subsidiaries perform poorly. Beginning in the second year following the carve-out, minority-owned subsidiaries exhibit negative abnormal operating returns which deteriorate further in subsequent years. Minority-owned subsidiaries which share top executives with their parents perform especially badly. Subsidiaries that switch from the majority- to the minority-owned group also demonstrate a significant decline in operating performance.

Second, we show that the relation between subsidiary value and parent ownership stake is nonlinear. Minority-owned subsidiaries are valued at a median discount of 23% relative to their peers; in contrast, fully divested subsidiaries have similar valuations to peers, while valuations of majority-owned subsidiaries actually increase with parent ownership stake. In fact, high levels of parent ownership translate into a valuation premium. We also find evidence that among all announcements of ownership change events, a subsidiary’s returns are lowest around a change in parent ownership from a majority to a minority stake.

Overall, our study suggests that blockholder opportunism, while not necessarily common in the United States, still poses a potential risk for small shareholders.

The full paper is available for download here.

Full post as published by The Harvard Law School Corporate Governance Blog on August 12, 2009 (boomark / email).