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Blockholders and Private Benefits

The idea that economic and political rights are granted in proportion to investments made by diffused shareholders constitutes a “central premise in modern financial theory”. Nevertheless, even in the Anglo-saxon countries, the fact that a single shareholder owns a relevant stake, (more than 10%, 15% or even 50%) is very common, so that there is a possibility that some private benefits could be extracted by them. Do these private benefits exist? Would stock prices reflect these benefits if they existed?

Although researchers had studied the connection between blockholder existence and corporate decisions and had also analysed the different systems that help blockholders to remain controlling firms, (dual-class stocks, supermajority voting systems and so on), empirical works on the existence, volume and determinants of private benefits were not numerous. One of these studies was done by Barclay and Holderness in 1989 (1).

Their main hypothesis was that the existence of a price premium for blocks (over the post-offer exchange price) would mean private benefits were being extracted by blockholders, given their voting power. In general blocks are not broken up and then sold, (the price premium would be lost), which makes their thesis quite reasonable.

These benefits can be:

  1. Pecuniary, such as higher payments to blockholders, (salaries, director pay, etc), or below market transfer prices for the company`s goods, (in the case the block is a substitute for vertical integration), etc.
  2. Amenities for blockholders,
  3. Production synergies.

If blockholder costs existed they would reduce the premium; if these costs were high enough, the block would receive a negative premium, so that sellers should break the block up and then sell the shares; but, if the blockholding offered some value, (its monitoring function, for instance), the broken up block would perhaps be sold at an even bigger discount, which justifies that blocks are seldom broken up.

Barclay and Holderness also analyse two alternative proposed causes for block premiums:

  1. One hypothesis proposes that trading parties for blocks have superior information; Barclay and Holderness don`t find empirical evidence for this.
  2. The other suggests that hubris, excessive optimism by the auction`s winner, could justify the premiums as over-payments, which is not empirically supported either.

The authors obtain certain relevant results from their empirical research:

  1. Usually blocks are traded at higher prices, roughly 20% more that what smaller investors receive; the dollar value of premiums represents 13% of the average block purchase price and 4% of the firm`s equity value in average,
  2. The absolute value of premium increases at a decreasing rate with firm size,
  3. The absolute value goes up at an increasing rate as the transferred fraction of common equity rises,
  4. Firms with higher leverage, lower volatility, and more cash and marketable securities also see their premiums increase,
  5. Poor performance before an offer decreases the premium, or even converts it into a discount.

As to the determinants of private benefits, Barclay and Holderness suggest and analyse some ideas:

  1. The characteristics of the block, mainly the fraction of common equity that it represents, can determine the volume of private benefits to be extracted: the higher the fraction, the blockholder would have more power to nominate directors, be protected from takeovers or proxy contests; nevertheless, when a certain threshold is reached (or other securities are included in the block) no more benefits would be obtained and perhaps the costs would turn the premium into negative. The empirical relationship is nevertheless highly relevant for blocks over 25%, not so much for lower blocks.
  2. Individuals will probably look for higher salaries or perquisites, while corporate blockholders will rather pursue production synergies.
  3. Firm size, (increases costs and benefits of holding a block, but the authors find a positive but decreasing  correlation),
  4. The asset structure, (benefits are easier to get the higher cash and liquid assets are present in the balance sheet, and there is empirical support),
  5. The capital structure, (although the effect of debt is not clear, the idea that highly leveraged firms are more easily controlled by blockholders is empirically backed),
  6. Stock-returns variance, (risk-averse block holders would pay less when stocks have previously given volatile returns; the hypothesis is backed when blockholders are individuals, as they might be less diversified than firms),
  7. Financial difficulties, (blocks would be lower as costs are higher in the case of distressed firms; empirical data support this).

(1) “PRIVATE BENEFITS FROM CONTROL OF PUBLIC CORPORATIONS”, by Michael J. BARCLAY and Clifford G. HOLDERNESS downloadable at http://www.sciencedirect.com/science/article/B6VBX-45NHW7X-N/2/a09deac6ade22ac93c02f48c054021f2

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