CARESS Working Paper 01-06 Armando Gomes Walter Novaes

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CARESS Working Paper 01-06
Sharing of Control as a Corporate Governance Mechanism
Armando Gomes
The Wharton School
2300 Steinberg Hall-Dietrich Hall
Philadelphia, PA 19104
Walter Novaes
∗
Department of Finance, Box 353200
University of Washington
Seattle, WA 98195
December 7, 2000
Abstract
This paper identifies a new corporate governance mechanism: sharing control. We show
that bargaining problems among multiple controlling shareholders may prevent inefficient
investment decisions that harm minority shareholders. The same bargaining problems may
block efficient investment decisions, though. By solving this trade-off, we show that the
likelihood that shared control is efficient increases with three firm characteristics: overinvestment problems, the cost of verifying cash flows, and financing requirements. The
model provides testable implications for the role that large shareholders play in corporate
governance, contrasting shared control and monitoring as alternative governance mechanisms.
jel: G30, G34, G32. keywords: Sharing of control, corporate governance, monitoring,
investment decisions.
∗
We would like to thank Yakov Amihud, Chris Geczy, Gary Gorton, Dennis Gromb, Matthias Kahl, Oded
Sarig, and seminar participants at University of Chicago and the 1999 AFE meeting in New York for valuable
comments. Gomes also thanks the support of the Rodney L. White Center for Financial Research.
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wkdw wkh rswlpdo htxlw| vwdnh ri d vlqjoh frqwuroolqj vkduhkroghu lv  ? 4 dqg wkdw wkhuh lv
qr prqlwru1 Wkh vlqjoh frqwuroolqj vkduhkroghu zloo lqyhvw li dqg rqo| li  | . e A 31 Wkh
frqglwlrq S ure^| . e ? 3> | . e A 3` A 3 iru dq| 5 ^3> 4, wkhq dvvxuhv wkdw wkhuh zloo eh
ryhulqyhvwphqw zlwk srvlwlyh suredelolw| hyhq li @ S ure^| . e ? 3` $ 41 Doorz qrz iru
prqlwrulqj1 Wkhq wkh prqlwru pd| dyrlg ryhulqyhvwphqw zkhq | . e ? 3 dqg  | . e A 31
Krzhyhu/ h{fhvvlyh prqlwrulqj zloo uhvxow li | . e ? 3 dqg | A 3/ zklfk/ e| dvvxpswlrq ri wkh
Sursrvlwlrq/ lv dq hyhqw zlwk srvlwlyh suredelolw| iru dq| 1 Wkhuhiruh/ zh frqfoxgh wkdw dq|
rzqhuvkls vwuxfwxuh zlwk d vlqjoh frqwuroolqj vkduhkroghu fdqqrw uhdfk wkh uvw ehvw zkhq lv forvh wr 41
Surri ri Sursrvlwlrq 9
Dvvxph e| devxug wkdw/ iru dq| +e> |,/ wkhuh h{lvwv d frqwuroolqj vkduhkroghu l+e> |, zkr fdq
vxffhvvixoo| dftxluh ixoo frqwuro sd|lqj iw +e> |,j 'EKc+ wr wkh rwkhu frqwuroolqj vkduhkroghuv1
Qrwh wkdw zh doorz wkh sd|phqwv wr eh frqwlqjhqw rq wkh dfwxdo sulydwh ehqhwv ri doo frq0
wuroolqj vkduhkroghuv/ ljqrulqj wkh vljqdov1 Wklv iroorzv wkh Uhyhodwlrq Sulqflsoh/ zklfk doorzv
xv wr uhvwulfw dwwhqwlrq wr gluhfw phfkdqlvpv1 Dv wkh vlqjoh frqwuroolqj vkduhkroghu/ vkh zrxog
lqwhuqdol}h doo ri wkh sulydwh ehqhwv/ lqyhvwlqj li dqg rqo| li e . | A 3/ zkhuh S2
' 1 Li
vr/ wkh rxwfrph ri wkh vdoh fdq eh uhsolfdwhg e| d gluhfw phfkdqlvp wkdw vhwv {+e> |, @ 4 li dqg
rqo| li e . | A 3/ zlwk wudqvihuv w +e> |, iru m 9@ l+e> |,/ dqg w +e> |, @ w +e> |,1 Wklv gluhfw
phfkdqlvp lv h{0srvw hflhqw/ zklfk/ dv zh vkrz qh{w lv qrw srvvleoh xqghu wkh dvvxpswlrqv
6:
wkdw/ diwhu wkh vljqdov uhdol}h/ d frqwuroolqj vkduhkroghu*v srvwhulru rq wkh sulydwh ehqhwv ri
wkh rwkhu frqwuroolqj vkduhkroghu lv lqghshqghqw ri khu rzq sulydwh ehqhwv1
E| wkh Uhyhodwlrq Sulqflsoh/ d gluhfw phfkdqlvp +{+=,> w+=,, ghvfulehv wkh rxwfrph ri
wkh frqwuroolqj vkduhkroghuv* edujdlqlqj sureohp li lw lqgxfhv wuxwkixo dqqrxqfhphqw ri wkh
surmhfw*v sd|rv dqg surylghv lqfhqwlyhv iru erwk frqwuroolqj vkduhkroghuv wr sduwlflsdwh lq
wkh phfkdqlvp1 Wr fkdudfwhul}h wkhvh wzr frqvwudlqwv/ ohw [ +|> e , @ H ^{+|> e > e ,` eh wkh
h{shfwhg suredelolw| wkdw wkh surmhfw zloo eh xqghuwdnhq frqglwlrqhg rq | dqg frqwuroolqj
vkduhkroghu l dqqrxqflqj e +wkh h{shfwdwlrq lv wdnhq zlwk uhvshfw wr e xvlqj wkh eholhiv ri
frqwuroolqj vkduhkroghu l,1 Olnhzlvh/ W +|> e , @ H ^w +|> e > e ,` lv wkh h{shfwhg qhw wudqvihu
wr vkduhkroghu l jlyhq e dqg |1 Jlyhq [ +=, dqg W +=,/ wkh h{shfwhg xwlolw| ri vkduhkroghu l
frqglwlrqhg rq dqqrxqflqj ae zkhq klv2khu wuxh sulydwh ehqhw lv e lv
X +|> ae > e , @ y +|> e ,[ +|> ae , . W +|> ae ,=
Fdoolqj X +|> e , X +|> e > e , wkh h{shfwhg xwlolw| ri wuxwkixoo| dqqrxqflqj e / wkh wuxwk0whoolqj
frqvwudlqw +LF, uhtxluhv wkdw
+LF,
X +|> e , X +|> ae > e ,
iru dq| l/ e / dqg ae =
Wkh lqglylgxdo udwlrqdolw| frqvwudlqw +LU, uhtxluhv wkdw vkduhkroghu l lv dw ohdvw dv zhoo r
lq wkh gluhfw phfkdqlvp dv lq h{huflvlqj klv2khu uljkw wr yhwr wkh surmhfw1 Irupdoo|/
+LU,
X +|> e , 3
iru dq| l dqg e 1
a
Ilqdoo|/ zh uhtxluh edodqfhg wudqvihuv/ wkdw lv/ iru dq| e=
+EE,
2
[
'
a @ 3=
w +|> e,
Zh wkxv vd| wkdw d gluhfw phfkdqlvp +{+=,> w+=,, lpsohphqwv wkh srvvleoh rxwfrphv ri wkh
edujdlqlqj jdph li dqg rqo| li lw vdwlvhv wkh LU/ wkh LF/ dqg wkh EE frqvwudlqwv1 Wkh iroorzlqj
Ohppd fkdudfwhul}hv wkh vhw ri lpsohphqwdeoh gluhfw phfkdqlvpv1
6;
Ohppd 5 +Lpsohphqwdeoh lqyhvwphqw srolflhv, Ohw {+=, eh dq| lqyhvwphqw srolf|/ I +e , eh
wkh frqwuroolqj vkduhkroghu l*v suredelolw| glvwulexwlrq +diwhu wkh uhdol}dwlrq ri wkh vljqdov, rq
wkh sulydwh ehqhwv ri wkh rwkhu frqwuroolqj vkduhkroghu/ dqg i +=, wkh ghqvlw| ixqfwlrq1 Iru dq|
|/ wkhuh lv d yhfwru ri vlgh sd|phqwv w+=, vxfk wkdw wkh gluhfw phfkdqlvp +{+=,> w+=,, vdwlvhv
wkh LF/ LU/ dqg wkh EE frqvwudlqwv li dqg rqo| li [ +|> e , lqfuhdvhv zlwk e iru hdfk l dqg
H
% 2 [
'
&
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e . | {+|> e,m| 3=
i +e ,
+45,
Surri ri wkh Ohppd1
Vwdqgdug dujxphqwv lq wkh phfkdqlvp ghvljq olwhudwxuh suryh wkdw d gluhfw phfkdqlvp
+{+=,> w+=,, vdwlvhv wkh LF frqvwudlqw li dqg rqo| li/ iru dq| frqwuroolqj vkduhkroghu l/
+LF 4,
X +|> e , @ X +|> e , .
+LF 5,
[ +|> e , [ +|> e ,
] K
[ +|> e ,ge
+46,
iru dq| e e =
+47,
K
Soxjjlqj X +|> e , @ H3 ^{+|> e > e3 ,y +|> e ,` . W +|> e , lqwr frqvwudlqw +LF04, rewdlqv
H3 ^{+|> e > e3 ,y +|> e ,` . W +|> e , @ X +|> e , .
] K
K
[ +|> e ,ge =
+48,
Wdnlqj wkh h{shfwdwlrq +ryhu e , rq htxdwlrq +48, dqg vxpplqj ryhu doo l |lhogv
2
[
H^
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2
[
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2 ] 7K ] K
[
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K
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+49,
S2
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U7 U
U7
vwudlqw +EE,,1 Lqwhjudwlqj e| sduwv KK KK [ +|> e ,ge i +e ,ge |lhogv KK +4I +e ,,[ +|> e ,ge 1
zkhuh zh xvhg wkdw
Wklv lpsolhv
2
[
H^
'
y +|> e ,{+|> e,` @
2
[
'
X +|> e , .
2 ] 7K
[
4 I +e ,
' K
+
i +e ,
,[ +|> e ,i +e ,ge =
Wkh LU frqvwudlqw lpsolhv X +|> e , 3 iru dq| e / khqfh X +|> e , 3 ,
6<
+4:,
S2
' X +|> e , 31
Xvlqj wklv lqhtxdolw| lq htxdwlrq +4:, jlyhv xv
] 7K ] 7K2 [
2
2
\
4 I +e ,
i ^y +|> e , +
i& +e& ,ge& 3=
,`{+|> e,j
i +e ,
K2 '
&'
K
Iurp Ohppd 5/ iru dq h{0srvw hflhqw phfkdqlvp qrw wr eh lpsohphqwdeoh/ lw vxfhv wr
suryh wkdw
L@
[
] ] [
2 e . | 3
'
e . | 2
4 I +e , \
i+e& ,ge& ? 3=
i +e ,
&'
+4;,
Frqvlghu wkh iroorzlqj fkdqjh ri yduldeohv= { @ +e .  |, > {2 @ e2 . 2 |= Ohw wkh
ghqvlw| dqg fxpxodwlyh glvwulexwlrq ri { eh/ uhvshfwlyho|/ i dqg I +e| dq dexvh ri qrwdwlrq,
zlwk vxssruw lq wkh lqwhuydo ^{ > { ` zkhuh { @ e .  | / { @ +e .  |,/ {2 @ e2 .2 |/
dqg {2 @ e2 .2 |= Rqh fdq hdvlo| fkhfn wkdw wkh dvvxpswlrq ri wkh sursrvlwlrq lpsolhv {2 ? {
dqg {2 ? { = Xvlqj wkh irupxod iru wkh lqwhjudo zlwk d wudqvirupdwlrq ri yduldeohv zh kdyh
wkdw/
L@
] %2 ] 4?t%2 c% %2
%
+^{2 4 I2 +{2 ,
I +{ ,
` ^{ .
`,i +{ ,i2 +{2 ,g{ g{2
i2 +{2 ,
i +{ ,
+4<,
P|huvrq dqg Vdwwhuwkzdlwh +4<;6, vkrz wkdw wkh deryh lqwhjudo lv qhjdwlyh xqghu wkh
dvvxpswlrqv ri wkh Sursrvlwlrq1 Dq h{0srvw hflhqw phfkdqlvp lv wkxv qrw lpsohphqwdeoh/
frqwudglfwlqj wkh lqlwldo dvvxpswlrq wkdw wkh frqwuroolqj jurxs fdq eh dozd|v glvvroyhg1
73
Table 1
Public Companies with Shareholders’ Agreements in Italy
Number of
Median number Median percentage
of shares in the
Companies of shareholders in
agreement
the agreement
Buy-out Agreements
Voting Agreements
Control Agreements
Any Agreement
52
(17.16%)
39
(12.87%)
20
(6.6%)
58
(19.14%)
4.5
50.6%
4.0
51.0%
6.0
50.4%
4.0
50.8%
This table shows the fraction of the 303 Italian public firms with shareholders’ agreements, as reported by
the “Ownership Structure of Companies Listed on Stock Exchanges in Italy,” CONSOB, December 1996.
Buy-out agreements impose restrictions on the transferability of shares. Voting (or pooling) agreements force
the participants of the agreement to vote with the group. Control agreements set corporate policies that
otherwise would be decided by the board of directors. Any agreement refers to firms that have any of the
previously mentioned shareholders’ agreements. Numbers in parenthesis show the percentage of the 303
public firms that have the agreements.
Table 2
Close Corporations in the U.S.
Full
Sample
Manager-Owned
Firms
Non-ManagerOwned Firms
310
223
87
64,708
46,990
17,718
Average number of employees
98.0
98.7
95.9
Average asset value ($ million)
7.5
6.9
9.2
Average annual sales ($ million)
23.3
22.4
25.6
3.0
(74.4)
3.0
(7.9)
10.0
(250.7)
Number of firms with at least one
large shareholder -- %
86.9
93.7
69.0
Number of firms with multiple large
shareholders -- %
57.2
69.4
24.9
Probability of having multiple large
shareholders conditioned on having at
least one large shareholder -- %
65.8
74.0
36.1
Number of firms with minority
shareholders -- %
67.7
60.6
86.7
Observations
Number of firms
Median (Average) number of
shareholders
45.6
55.2
20.7
Probability of having multiple large
shareholders conditioned on having
minority shareholders and at least one
large shareholder -- %
The NSSBF database includes 4,637 firms with less than 500 employees that answered the 1992 National
Survey of Small Business Finances. Out of these 4,637 firms we extracted the close corporations with more
than one shareholder and annual sales above $10 million, ending up with our full sample of 310 firms.
Manager-Owned Firms excludes firms where the manager is not a shareholder, while Non-Manager-Owned
Firms includes only firms where the manager is not a shareholder. Observations give the number of firms in
each sub-sample. Number of firms gives the NSSBF estimate of the number of firms that each sub-sample
would have if all firms had answered the survey. For the estimated number of firms of each sub-sample,
Average number of employees, Average asset value ($ million), and Average annual sales ($ million) give,
respectively, the average number of employees, and the average book value of assets and annual sales in
millions of dollars. Median (Average) number of shareholders is the median (average) number of
shareholders of the estimated number of firms in each sub-sample. Number of firms (condition)- % is the
fraction of the estimated number of firms satisfying the (condition) over the estimated number of firm in
each sub-sample in percentage terms. A firm is said to have multiple large shareholders if two shareholders
have at least 10% of the shares and one of them has more than 20%. A firm has one large shareholder if at
least one shareholder has more than 20% of the shares while the other shareholders have less than 10% of
the shares. A firm has minority shareholders if there are no large shareholders or if there is a shareholder
with less than half of the shares of a large shareholder.
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