Ownership Concentration and Corporate Control

Abstract

Corporate finance and corporate governance mechanisms differ sharply across countries. For example, in the United States and the United Kingdom firms are widely thought of as relying primarily on the threat of a takeover by outsiders to ensure that managers act in the shareholders’ interest, while German and Japanese firms are thought to be governed by the banks with which they have close ties. What are the reasons for these striking differences? What are the costs and the benefits of the different mechanisms of corporate control? In this Chapter we will address these issues by describing the main characteristics of the corporate control mechanisms in large non financial firms in the United States, the United Kingdom, Japan and Germany. Moreover, we will try to shed light on the question of why these differences exist. The dominant theme of this Chapter (see also Prowse, 1994, for a similar approach) is that concentrated holdings of a firm’s financial claims may be the most efficient way of resolving agency problems in firms (see, e.g., Stiglitz, 1985). The intuition is very simple. Suppose, firstly, that the equity of the firm is concentrated in the hands of a few investors. Then each investor will have sufficient private incentive to invest in information acquisition and monitoring of management. Moreover, large shareholders will be in a position to exert control over management. This can be achieved either through their voting rights or through representation on the board of directors, or both. The limited diversification which these investor can achieve is, of course, the cost of their large stakes. Suppose now that the firm’s debt is concentrated in the hands of few banks or other lenders. Again, these institutions will have an incentive to engage in monitoring. There is, however, a difference. The point here is that “lenders are only interested in the bottom part of the tail of the distribution of returns” (Prowse, 1994, p.12), and they therefore tend to be less interested in whether the managers are maximizing the value of the firm. This problem can be mitigated to the extent that the large lenders to the firms are also large shareholders.