Ownership as a Form of Corporate Governancepeople.tamu.edu/~ltihanyi/OwnershipJMS.pdf · integrate the vast literature on ownership as a form of corporate governance, ... in companies

Ownership as a Form of Corporate Governancejoms_929 1561..1589

Brian L. Connelly, Robert E. Hoskisson, Laszlo Tihanyi*and S. Trevis CertoAuburn University; Rice University; Texas A&M University; Arizona State University

abstract Firm ownership is an increasingly influential form of corporate governance.Although firms might be owned by different types of owners, most studies examine ownerinfluence on a particular firm outcome in isolation. This study synthesizes research frommultiple disciplines on different types of owners and offers a unifying framework of governancethrough ownership. Using this framework, we describe the motivations of various types ofowners, the tactics owners use to affect firms in which they are invested, and the dominantfirm outcomes these owners seek to influence. We note how heightened managerial awarenessof heterogeneous owner interests increases owner influence on firm-level outcomes. We alsoprovide a roadmap for future study and offer research questions about where scholars mightturn their attention to better understand the role of owners in directing firm actions. Our studydraws attention to emerging forms of ownership, such as hedge funds and sovereign wealthfunds, and highlights the changing (and often competing) interests of shareholders and howthis impacts theories of governance.

INTRODUCTION

The popular press often associates corporate governance with the board of directors.However, there are a wide range of mechanisms in place that govern, or control, theactions of managers. Some of these mechanisms are internal to the firm, such as theboard of directors and executive compensation structures. Others are external, such asthe market for corporate control, the competitive environment, local laws, and bothformal and informal institutions (Walsh and Seward, 1990). This study reviews theinfluence of the firm’s owners as an increasingly important, and influential, group thatgoverns the actions of managers and constitutes both an internal and external controlmechanism. We focus on general governance problems involving firm owners using theexamples of mainly US and UK firms, while a companion study in this issue by Johnsonet al. (2010) addresses variation in ownership influences in different institutional contexts.

Address for reprints: Brian L. Connelly, Auburn University, 415 W Magnolia Ave, Auburn, AL 36849, USA([email protected]).

*Note that this paper was under review before Laszlo’s appointment as Associate Editor at JMS.

© 2010 The AuthorsJournal of Management Studies © 2010 Blackwell Publishing Ltd and Society for the Advancement of ManagementStudies. Published by Blackwell Publishing, 9600 Garsington Road, Oxford, OX4 2DQ, UK and 350 Main Street,Malden, MA 02148, USA.

Journal of Management Studies 47:8 December 2010doi: 10.1111/j.1467-6486.2010.00929.x

Recent years have seen sweeping changes to ownership structures and their influenceon firm actions. Institutional investors have become some of the most active owners incorporate history, often confronting managers and directors and even seeking tochange the make-up of boards and top management teams (Dai, 2007). For example,D.E. Shaw Investments played an important role in the 2008 ousting of the CEO ofTake-Two, maker of the popular Grand Theft Auto video game. Such drastic actionsare often precipitated by activist investors, who now hold the majority of US and UKpublic equity (Almazan et al., 2005). The reach of these activist investors has extendedsuch that they are often able to pressure management to undertake specific competitiveactions (Connelly et al., in press). One example is Relational Investors, a mutual fundheaded by Ralph Whitworth, which assumed a large share of Home Depot and quicklyforced management to divest its contractor services business (Liang, 2007). Executivestoday are in regular contact with their most influential shareholders, take actions inresponse to shareholder desires, and are cognizant that job security lies in the hands oftheir investors.

Despite broad and rapid changes regarding who owns firms and how they go aboutimposing pressure on boards and managers to act in specific ways, our academicunderstanding of these phenomena is advancing more slowly. Research exploring thegovernance function of firm owners is still dominated by agency theory (Dalton et al.,2007), which may provide an over-simplified view of the nature of relationships betweena wide range of shareholders and managers. Furthermore, our understanding of theevolving structures of firm ownership is dispersed throughout an assortment of litera-tures, including finance (Demsetz and Villalonga, 2001), accounting (Bushee, 2001),economics (Gompers and Metrick, 2001), law (Bainbridge, 2003), and management(Hoskisson et al., 2002). Given the diverse approaches taken by various disciplines, thetime is right to take stock of what we know about the behaviour of different owners andhow they govern firm actions. In this review, we summarize theory that explains thegovernance role of owners, gather information that various disciplines have learnedregarding the nature and structure of firm ownership, and explore what scholars arediscovering about the tactics they use to influence managerial activities.

THEORETICAL FRAMEWORK

The seminal work of Berle and Means (1932) provides the foundation for researchexamining corporate ownership structures. The central premise of their work was therecognition of problems associated with the separation of ownership and management.Jensen and Meckling (1976) expanded these ideas significantly through the introductionof agency theory. According to agency theory, a firm represents a nexus of contractsbetween principals (owners) and agents (managers). Jensen and Meckling proposed thatowners and managers have contradictory risk preferences which may lead to managerialdecisions that depart from shareholder preferences. While some scholars have ques-tioned the extent to which manager and shareholder preferences diverge (Ghoshal,2005), the vast amount of research relying on agency theory demonstrates that thisassumption resonates with scholars (Dalton et al., 2007). Therefore, to ensure the inter-ests of managers and shareholders are aligned, research suggests the appropriateness of

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© 2010 The AuthorsJournal of Management Studies © 2010 Blackwell Publishing Ltd andSociety for the Advancement of Management Studies

several internal monitoring mechanisms, such as boards of directors and executivecompensation contracts (Dalton et al., 1998).

Ownership structures play a central role in determining the extent to which theinterests of owners and managers are aligned (Dalton et al., 2003). In an effort tointegrate the vast literature on ownership as a form of corporate governance, we havelinked ownership structure, the actions owners take, and firm attributes in a descriptivemodel, shown in Figure 1. Path A illustrates the relationship between a firm’s ownershipmix and the various alternatives open to owners in terms of influence. Path B illustrateshow shareholder influence may impact important firm attributes such as performanceand strategy. Path C highlights the notion that different investors take ownership stakesin companies owing to the presence of certain firm attributes such as performance orstrategy. This final path illustrates the influence of endogeneity, which represents animportant factor in understanding firm ownership. More specifically, ownership is notexogenous but instead closely tied to the decisions managers make regarding competitivetactics and strategies (Bushee, 2004; Demsetz and Villalonga, 2001). In the followingsections, we discuss the three main components of our model and the complex relation-ships that underlie each path.

OWNERSHIP STRUCTURE

Firms may be owned by a diverse mix of different types of investors. With few exceptions,these investors become owners in firms to accomplish financial objectives. However, they

OWNERSHIP STRUCTURE

A

BC

OWNER INFLUENCE

RESTRUCTURING

ACTIVISM

BUY-AND-HOLD

ATTRIBUTES

PERFORMANCE

STRATEGY

GOVERNANCEPROCESSES

FIRM OUTCOMES/

INSIDE OWNERSHIP

OUTSIDE OWNERSHIP

Figure 1. Descriptive framework of ownership as a form of corporate governance

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Society for the Advancement of Management Studies

may differ with respect to their trading styles, clientele, legal and regulatory environ-ments, and their ability to gather and process information. In this section, we review thedominant forms of ownership that researchers have examined in the governance litera-ture and discuss factors that motivate them to own some, or most, of the firm. Table Isummarizes some of the key studies that examine the governance role of these differentforms of ownership.

Inside Ownership

Equity owned by insiders helps align the interests of managers and shareholders, whichDalton et al. (2003) call the ‘alignment’ approach. These insiders tend to be motivatedto make decisions that are consistent with interests of the broader constituency ofshareholders.

Executives. Scholars in finance (Agrawal and Knoeber, 1996), law (Perry and Zenner,2000), economics (Himmelberg et al., 1999), and strategy (Dalton et al., 2003) haveexamined when and how insider equity supports alignment between the interests ofowners and managers. The appeal of this perspective lies in its simplicity: as executivesgain greater ownership stakes, they are more likely to employ firm resources towardslong-term profitability and less likely to shirk from executing their fiscal and strategicresponsibilities ( Jensen and Meckling, 1976). At the same time, however, other scholarsnote the potential pernicious effects of managerial ownership. High levels of ownership,for example, may provide executives with increased power, which can cause them tobecome entrenched within the firm (Morck et al., 1988). Once entrenched, managersmay consume more perquisites and/or reduce the firm’s risk profile to protect their owninterests.

Consistent with these contrasting perspectives, empirical support for the effects ofmanagerial ownership has been mixed (Dalton et al., 2003; Himmelberg et al., 1999;McGuire and Matta, 2003). For example, the results of some studies show that executiveownership leads to greater risk taking (Rajgopal and Shevlin, 2002) whereas others reportthe opposite effects (Desai and Dharmapala, 2006). Similarly, some studies have soughtto establish a link between managerial ownership and goal alignment, but other researchhas found that managerial ownership may as often lead to goal misalignment withrespect to such issues as backdating of stock options, earnings manipulation, and divi-dend policies (Bhattacharya, 1981; Devers et al., 2007).

Board members. Others have applied the alignment principle to board members (Herma-lin and Weisbach, 2003). The equity holdings of independent directors have not cap-tured the same research attention as that of inside directors and other executives because,from an agency theory perspective, independent directors should already represent theinterests of shareholders. At the same time, independent directors have both access tofirm-specific information that may not be available to other investors and some elementof control over firm actions (Kosnik, 1990). There is, in fact, some evidence that changein the equity holdings of board members can signal the long-term earnings potential ofthe firm to other owners (Certo et al., 2001). Although independent directors vary



Table I. Summary of key research on ownership structure as a form of governance

Owner type Key issues Studies addressing the issue

Executiveownership

Empirical support for the agency theory benefits ofexecutive ownership has been mixed.

Dalton et al., 2003McGuire and Matta, 2003

Studies show conflicting evidence about howexecutive ownership influences risk-taking and goalalignment.

Rajgopal and Shevlin, 2002Desai and Dharmapala, 2006Devers et al., 2007

Board ownership Board ownership signals long-term earnings potential. Certo et al., 2001Outside directors vary considerably in theirownership, but less empirical research focuses on thisgroup.

Hermalin and Weisbach, 2003Kosnik, 1990

Employeeownership(non-executive)

Creates a social-psychological bond that is linkedwith effectiveness, satisfaction, and performance.

Blasi et al., 2003Jones and Kato, 1995

Scholars explain these relationships with an extrinsicor instrumental satisfaction model.

Welbourne and Gomez-Mejia,1995

Buchko, 1993

Blockholders Empirical research on individual ownership isfocused on insiders, usually ignoring individualoutsiders or lumping them together with institutionalinvestors.

Holderness, 2003Shleifer and Vishny, 1997Mehran, 1995

Family ownership rarely creates value as theseowners seek to protect their socio-emotionalendowment.

Anderson and Reeb, 2003Gomez-Mejia et al., 2003

Corporate ownership can have negative implicationsfor the target firm.

Bogert, 1996Rosenstein and Rush, 1990

Empirical research highlights the problems associatedwith state ownership, such as soft budgets, decreasedinnovation, corruption, and limited competition.

Tihanyi and Hegarty, 2007Megginson and Netter, 2001Shirley and Walsh, 2001

Multiple blockholders create power-dependencies. Maury and Pajuste, 2005

Agent owners Overcome obstacles to governance encountered byother shareholders, but also create a dual agencyrelationship.

Arthurs et al., 2008Grinstein and Michaely, 2005

Pressure-sensitive institutional investors are poorgovernors of firm activity.

Edwards and Hubbard, 2000

Pressure-indeterminate institutional investors do nothave a systematic governance role.

Brickley et al., 1988

Pressure-resistant institutional investors have a stronginfluence on a wide range of firm outcomes.

Tihanyi et al., 2003David et al., 2001

Short-term and long-term institutional investors havedifferent, and sometimes competing, interests.

Connelly et al., in pressDavid et al., in press

Private equity Venture capitalists may be inactive, active-advice-giving, or hands-on; they may work togetherin syndicates.

Elango et al., 1995Lockett and Wright, 2001

The influence of business angels and venturecapitalists varies with their institutional environment.

Bruton et al., 2009




considerably with respect to their equity positions, the influence of these variations onfirm actions and the holdings of other owners remains unclear.

Non-executive employees. Thousands of firms are structured in such a way that mostemployees own at least some stock; many more utilize programmes where employeesas a whole acquire appreciable shares of the firm (Blasi et al., 2003). Although interestalignment and gain sharing (Welbourne and Gomez-Mejia, 1995) are at the heart ofthis form of ownership, the emphasis is more on creating a social-psychological bondthat affects job attitudes (Pierce et al., 1991). Employee ownership can reduce turn-over, absenteeism, and grievances while increasing effectiveness, satisfaction, andoverall firm performance ( Jones and Kato, 1995). Scholars explain these positiveresults in at least two ways: extrinsically and intrinsically (Buchko, 1993). An extrinsicsatisfaction model sees the appreciation of share price as the primary driver behindgains in employee effectiveness and commitment. An instrumental satisfaction modelsuggests these gains emerge more as a result of added control and influence. Eitherway, the goal of this ownership structure is to establish a link between an outcome ofimportance to employees and firm performance. Not all empirical research, however,has supported this link; a meta-analysis by Kruse and Blasi (1995) found no overallconclusion about whether firms with these plans had better performance than firmswithout them.

Outside Ownership

Complementing the alignment approach, equity held by outsiders may help to motivatethese shareholders to monitor more carefully the actions of managers; Dalton et al.(2003) refer to this as the ‘control’ approach.

Blockholders. The Securities and Exchange Commission (SEC) has defined blockholdersas any investor with more than a 5% equity stake in the firm. Two main factors motivatelarge block ownership by outsiders: concentrated control and private benefits. Concen-trated control arises from the superior monitoring that blockholders can perform viaconcentrated decision rights. On the other hand, blockholders also have incentive to usetheir power over management to enjoy benefits not shared with minority shareholders.Barclay and Holderness (1989), for example, found evidence of the private benefits ofblockholders in trades that were, on average, priced at a premium over subsequent tradesof other shareholders. Firms may also repurchase stock above market price via privatetransactions with a dissident blockholder. Firms typically engage in such greenmailtransactions to avoid a takeover threat or proxy fight initiated by the blockholder(Kosnik, 1990). Individual blockholders are distinct from institutional investors becausethey are not beholden to any particular clientele. We also draw a distinction betweenexternal blockholders and those inside the firm (i.e. executives and directors) becausetheir objectivity makes them better able to monitor firm actions. However, some havenoted that individual large-block shareholders typically serve as directors or officers ofthe firm (Holderness, 2003). As a result, empirical research usually either ignores



individual outside blockholders or lumps them together with institutional investors,despite potential differences (Mehran, 1995; Shleifer and Vishny, 1997).

Family members, however, are one category of individual blockholder that has beenthe subject of considerable academic attention (Anderson and Reeb, 2003; Burkart et al.,2003; Schulze et al., 2003). The body of empirical research on family firms shows thatfamily ownership rarely creates value for the firm or its minority shareholders (e.g.Anderson and Reeb, 2003), except in cases where the founder serves as CEO (Villalongaand Amit, 2006). The companion review in this issue discusses the influence of familyfirms, especially in the broader international context, in greater detail ( Johnson et al.,2010).

Corporations also may become blockholders by acquiring a minority share of anotherfirm. Motivation for this type of blockholding varies, but more often than not it precedeseither a takeover or complete sale of the stock within a short period of time. Corporateblockholding is a mixed blessing for the target firm. The arrival of a corporate block-holder provides fresh capital that the firm may use to facilitate growth. However, thiscapital comes at a price because the target firm transfers some level of control to thecorporate blockholder, who itself is likely to have an interest in how the target firm’sresources are allocated. Rosenstein and Rush (1990) find that wealth transfer of goodsand services at prices favourable to the blockholder have negative implications for thetarget. This explains in part why empirical research has shown a negative associationbetween corporate blockholders and target firm performance (Bogert, 1996; Mikkelsonand Ruback, 1985).

A form of outside blockholding that has garnered popular attention in recent years isstate ownership. Although state ownership tends to be higher in emerging economies andthose with poorer protection of property rights (La Porta et al., 2002), it is also of interestin developed countries, including the USA and UK, where it has come about as a resultof market failures. Such a response may occur in industries characterized by naturalmonopolies and in markets of public goods or among firms that are deemed too big tofail. The question of which firms and industries should have state ownership and whichshould compete in open markets occupies a vast literature of its own (Anderson et al.,1999). Although there remains some theoretical debate on the issue, most empiricalstudies highlight the problems of state ownership (D’Souza and Megginson, 1999;Shleifer, 1998). These problems include ‘soft’ budget constraints, lack of innovation,poor financial performance, and increased corruption (Megginson and Netter, 2001;Tihanyi and Hegarty, 2007). Recognition of the benefits of private ownership hasspawned research about how best to privatize state owned firms (Shirley and Walsh,2001), with the preponderance of research being focused on transition economies(Djankov and Murrell, 2002).

A more subtle form of state ownership revolves around investors that are broadlycategorized as sovereign wealth funds (SWFs); these are investment vehicles owned andmanaged by a national government. In the last few years, SWFs have invested large sumsof capital in US, UK, and other developed economy firms, which has drawn theattention, and sometimes ire, of policymakers. Critics raise two main concerns: the lackof transparency of these owners and their potential for preferring political interests overeconomic and strategic gains ( Jen, 2007). Others point out that SWFs are typically




dedicated, patient investors that look beyond quarterly results and can be a stabilizingforce in turbulent markets (Gilson and Milhaupt, 2008). Most of the evidence to date,however, is anecdotal; academics have yet to fully address the issues surrounding thelargely political debate about how SWFs may potentially influence the firms in whichthey invest (Fotak et al., 2009).

Researchers examining blockholder ownership mainly consider the influence of aprimary outside blockholder with a very large stake (e.g. the state or a corporate ‘raider’).However, in most firms the presence of several smaller blockholders is more commonthan a single majority blockholder (Maury and Pajuste, 2005). To the extent theirinterests are aligned, blockholders may work together to enhance their concentratedcontrol. However, the SEC imposes limits on the collective action of shareholders in aneffort to maintain stock market liquidity and avoid collusion among blockholders. Fur-thermore, blockholders may be in competition with each other to gain private benefits.The interests and influence of blockholders do not exist in isolation. There is therefore agood deal we do not yet understand about how blockholders interact with one anotherto influence a firm’s actions.

Agent owners. Another set of outside owners is those that invest in the firm as represen-tatives of an underlying fractionated ownership. This creates a dual agency relationship(Arthurs et al., 2008) wherein shareholders serve as principals, discharging duties withregard to managerial agents, and also as agents who are themselves charged with theduty of investing towards particular objectives of ultimate shareholders in a particularfund.

There are several reasons to suggest that agent owners are able to overcome obstaclesto firm governance encountered by other shareholders. Agent owners represent fraction-ated clients who sign over their voting rights, centralizing bargaining power in a singleentity and avoiding campaign costs. Owing to a changing regulatory environment intheir favour, agent owners can sometimes combine their bargaining strength. With theirlarge holdings, these owners have the incentive and resources to monitor firm actions(Pound, 1988). They benefit from membership in dedicated coordinating bodies, whichgives them access to research and inside information not available to other investors(Grinstein and Michaely, 2005). These organizations combine with agent owners’ ownprofessional staff to increase monitoring effectiveness (Ke and Petroni, 2004).

Researchers have categorized various forms of agent owners differently in the finance(Brickley et al., 1988), management (Tihanyi et al., 2003), and accounting (Bushee, 1998)literatures. These include categories such as pressure-sensitive/pressure-indeterminate/pressure-resistant, dedicated/transient/quasi-indexer, and transactional/relational. Acommon theme among these disparate classifications is that agent owners have differentinvestment preferences and abilities to govern firm actions (Hoskisson et al., 2002). Agentowners have received considerable research attention, as discussed by Johnson et al.(2010) in their review.

Private equity. In the landscape of firm ownership there are also a great many organiza-tions that compete in the marketplace but are not publicly traded. From the early stagesof a firm’s life, their ownership is often composed of some combination of founding



investors and close associates, or ‘business angels’. Business angels are early stage inves-tors that arrive at a time when the venture is too small and risky for more formalprivate equity funds (Prowse, 1998). An often-studied form of private equity is venturecapital, which is long-term, unquoted, risk equity from professional investors whoseprimary reward is capital gain (Wright and Robbie, 1998). Venture capitalists governfirms by controlling the flow of cash disbursements and providing oversight of manage-rial activity (Gompers, 1995). Because young firms rely heavily on the cash provided byventure capitalists, these owners have particularly strong bargaining power over man-agers (Zacharakis and Shepherd, 2001). In a manner similar to the categorization ofinstitutional investors, the literature distinguishes between ‘inactive’, ‘active advicegiving’, and ‘hands-on’ venture capitalists (Elango et al., 1995), with the latter exercisingthe most extensive governance. Many venture capitalists are also agent owners thatrepresent the interests of a group of principals who seek to ensure that gains aredistributed equitably and that the venture capitalists fulfil their monitoring role.However, recent research suggests that venture capital interests, as well as those ofbusiness angels, can vary given the institutional setting of the country in which they arebased (Bruton et al., 2009).

As firms grow, other private equity may come to the fore, often in the form ofleveraged buyouts ( Jensen, 1989). In contrast to the limited involvement of venturecapital firms in early stage investments, private equity firms in leveraged buyouts tend toobtain majority control in mature firms (Kaplan and Strömberg, 2009). The involvementof private equity firms in the management of corporations may bring important changesto firm governance, including the development of corporate codes, reduction of agencyproblems, and improved monitoring of management (Cumming et al., 2007). Privateequity firms may also develop highly leveraged capital structures and performance-basedmanagerial compensation (Kaplan and Strömberg, 2009). The involvement of privateequity firms has been found to result in reduced innovation but higher return to share-holders (Cumming et al., 2007).

A MODEL OF OWNERSHIP, INFLUENCE, AND FIRM OUTCOMES

Having summarized the dominant forms of ownership in the USA and UK, we turn ourattention to firm-level outcomes that have occupied the attention of owners and how theyinfluence those outcomes. The model in Figure 1 incorporates three paths across thethree primary components, including a feedback loop. The following sections outlineextant research examining each of these paths.

Ownership Structure and Owner Influence

Path A in Figure 1 illustrates the relationship between ownership structure and ownerinfluence. The ‘Wall Street walk’ suggests that owners can sell their shares if they do notagree with executive decision making. However, in recent years shareholders of US andUK firms increasingly use tactics that are more sophisticated than the threat of exit. Forexample, owners may (a) seek to restructure the firm’s business activities or ownership, (b)work within the existing ownership structure but seek to influence managerial behaviour




through various forms of activism, or (c) adopt a non-activist, buy-and-hold strategy.Providing a realistic picture of the effectiveness of these owner tactics is complicated bya number of factors. For example, different owners may use different tactics based ontheir interest, organizational characteristics, and power (Ryan and Schneider, 2002).Firms are normally owned by multiple owners that interpret business conditions differ-ently and apply different tactics with a mixed overall effect on firm behaviour (Connellyet al., in press). Also, recent research has shown that managers use forms of ingratiationand persuasion to limit powerful investors from using their coercive power to forcechanges that could benefit shareholders at the expense of top management (Westphaland Bednar, 2008). Nevertheless, the potential influence of firm owners on corporategovernance and strategies remains.

Restructuring. Restructuring tactics by firm owners are illustrated by such examples asKraft Foods, EchoStar Holding, and Time Warner Cable. Employing corporate restruc-turing tactics successfully requires power, supporting institutions, and collective action(Davis and Thompson, 1994; Pfeffer and Salancik, 1978). Blockholders may exercisetheir power through restructuring when their tactic is consistent among a group ofblockholders. However, if their action is inconsistent with others, exit of a single block-holder may transfer power to the remaining blockholders (Admati and Pfleiderer, 2007).There is therefore a need for greater understanding of the actions of multiple owners andthe ways various forms of owners interact with each other.

Two common approaches to restructuring are spin-offs and sell-offs. Spin-offs createan additional publicly traded security for a new firm separate from the parent, whilesell-offs are assets sold to another parent. The spin-off of Philip Morris International(PMI), producer of Marlboro and other leading tobacco brands, for instance, wasmotivated by increasing regulatory constraints faced by parent company Altria. Thespin-off allowed shareholders to benefit from growth in emerging markets while reducingthe risk of litigation in Altria’s domestic market. Spin-offs are often used as restructuringtactics when firm performance is high or when it is difficult to find a buyer because of aclose relationship with the parent firm (Bergh et al., 2008; Johnson, 1996). Sell-offs, onthe other hand, are normally used to improve sagging firm performance. Sell-offs mightalso be used to generate state revenue (in privatization programmes), save employment,and improve production quality or service (Megginson and Netter, 2001; Tihanyi andHegarty, 2007).

Another common restructuring tactic is a leveraged buy-out (LBO), which is a privatepurchase of public equity, and its counterpart management buy-out (MBO), which is aprivate purchase by individuals inside the firm. In recent years, there has been consid-erable increase in MBOs and LBOs, resulting in vast private equity markets and renewedscholarly and policy attention (Cumming et al., 2007). CEOs and managers are inter-ested in participating in LBOs for a variety of reasons. First, executives are likely tobenefit personally from the deals, given their influence in establishing the ‘fair price’.They also may envision an LBO offering as an opportunity to run the company moreefficiently and entrepreneurially (Wright et al., 2000). LBOs may improve corporategovernance by reducing agency costs and increasing firm value through improvedoperating efficiency (Renneboog et al., 2007). These benefits are achieved primarily by



the actions managers take subsequent to an LBO, which include divesting poorly per-forming units, paring the workforce, and reducing managerial perquisites. Nikoskelainenand Wright (2007) show that this type of activity is most beneficial when LBOs aredominated by outsiders rather than managers. In either case, however, there appear tobe advantages to a firm’s governance structure (Wright et al., 2000).

Private equity firms using LBOs may restructure their firms by financial, governance,and operational engineering ( Jensen, 1989). Financial engineering occurs when privateequity firms not only require management to obtain substantial investment in the firm,but also make their investments illiquid until sale or valuation of the private firm (Kaplanand Strömberg, 2009). Leverage used to obtain control by private equity firms might alsomotivate managers to more carefully allocate capital resources. Governance engineeringrefers to direct involvement in boards by private investors. Operational engineeringdescribes value creation by private equity firms owing to their industry and operatingknowledge (Kaplan and Strömberg, 2009). By specializing in familiar industry settings,private equity firms are able to develop LBO expertise in repositioning, productivityimprovements, and restructuring tactics that may be more effective under specific envi-ronmental conditions.

Restructuring often results in improved firm performance. Thompson and Wright(1995) suggest three interrelated areas that tend to change as a result of restructuringtactics. First, managers may increase their efforts in cutting costs; MBOs and LBOs, inparticular, provide additional incentives for managers’ cost minimization efforts (Green,1992). Second, restructuring allows firms to divest unprofitable businesses ( Johnson,1996). Third, restructuring facilitates firms’ adaptation to changing market conditions(Wiersema and Bowen, 2008). Because restructuring tactics are not implemented inisolation, there may be groups of owners and other stakeholders who do not realize gainsin the short term or suffer in the long term. These stakeholders may include owners witha long-term equity stake in the firm, employees, or tax authorities (Fox and Marcus,1992; Thompson and Wright, 1995).

Activism. Owners in recent years have relied on diverse means to influence firms andtheir managers. The rise in owner activism may be an outcome of increasing ownershipconcentration, the upsurge of business information from multiple sources, and growingexpertise in investment firms and financial institutions. Davis and Thompson (1994)compare this process to social movements, in which owners define their common inter-est, develop social ties, and mobilize to jointly influence firm behaviour. Owners thatengage in activism tend to be large and pressure-resistant, have long time horizons, andown a considerable percentage of the firm (Ryan and Schneider, 2002). Such activismtakes a variety of forms, ranging from private meetings with management to hostilemedia campaigns. Meetings and behind-the-scenes bargaining with management arenon-aggressive ways to intervene in the firm’s daily operations. Shareholders can also putforward proposals under SEC Rule 14A-8, which is a relatively inexpensive tactic forowners because they can address issues without the costs associated with lobbyingindividual managers or shareholders (Sundaramurthy and Lyon, 1998). O’Rourke(2003), for example, identified 287 shareholder proposals aimed at improving corporatesocial performance (CSP), 98 of which were withdrawn because of compromise or




resolution. This suggests that shareholder proposals may be an effective means of accom-plishing desired ends, even if the proposal does not ultimately come to a vote.

Del Guercio et al. (2008) suggest that, despite their low cost, shareholder proposalshave not been very effective in changing firm behaviour and performance. These authorsconsider the effectiveness of ‘just vote no’ campaigns, which activist investors use topersuade other shareholders to withhold their vote on board members. These campaignsoften take place in the printed media or on the internet. In a separate analysis, DelGuercio et al. (2003) argue that the effectiveness of these campaigns may lie in thereputation of directors, who are likely concerned about a vote of no confidence beingreported in media outlets. These authors find evidence for the effectiveness of ‘just voteno’ campaigns in the forms of disciplinary CEO turnover and performance improve-ments. There remains therefore some degree of uncertainty about the extent to which theultimate fate of board members resides in the hands of shareholders and how shareholderpower to remove directors could affect decisions on the board.

Some owners increase their direct influence on firms by acquiring seats on the boardof directors. Ralph Whitworth’s Relational Investors, the activist mutual fund notedearlier, often attempts to take two board positions through its significant ownership. Bydoing so, Relational Investors is able to second its motions and the board must thenrecord its vote on critical issues (Liang, 2007). Another means of activism, proxy contests,can be employed to unseat boards of directors whose decisions do not adequatelyrepresent the goals of activist owners. Proxy contests are often associated with failedtakeover attempts or managers who refuse a takeover offer that otherwise is attractive togroups of influential owners.

Buy-and-hold. Many owners hesitate to intervene when they see performance problems ina firm, preferring instead to display loyalty to management. For example, the indexingapproach used by many mutual and pension funds disregards individual firm behaviour,concentrating on portfolios of firms across different industries. When an index investoradopts a buy-and-hold investment strategy, it does not necessarily abdicate its gover-nance role because the owner may have an important long-term influence on a firm’sability to compete. For instance, Hoskisson et al. (2002) found that these owners canfoster greater innovation, a finding confirmed in the accounting literature by Bushee(1998, 2001).

One way these owners affect firm strategies is via the patient capital they provide.When firms are burdened with transient ownership, they are required to focus moreon consistent, positive quarterly earnings. This limits the range of options available tothem when they consider possible R&D investments or strategic competitive actionsthat may entail short-term earnings shortfalls with long-term potential benefits. Forexample, General Mills acquired the worldwide Pillsbury business in October 2001. Asa result, earnings fell 48 per cent in the third quarter of that year. Although painful inthe short term, General Mills was in a better position to compete with Kellogg’s in theensuing years. Owners using a buy-and-hold strategy appear to have a greater toler-ance for, and understanding of, this kind of strategic competitive activity, and in factmay even be able to provide some of the resources necessary to implement suchactions.



Executives recognize that those employing a buy-and-hold strategy are particularlybeneficial for the long-term health of a firm. These managers sometimes even take actionto woo such investors. Examples of firms trying to accomplish this include Coca-Cola,PepsiCo, and AT&T, all of whom stopped issuing quarterly earnings reports becausethey were drawing attention away from long-term strategy (Bushee, 2004). Managersalso attempt to attract buy-and-hold investors via the content of their public disclosures.To do so, they focus disclosure activity on information that helps investors monitorlong-term prospects rather than earnings forecasts that may invite speculative trading.

Not all owners are equal in their ability to know about firms in their investmentportfolio. Some invest in a small number of firms and may be better able to understandthe business activity in which those firms operate; others are more broadly invested andcannot maintain such in-depth knowledge because of the bounded rationality of invest-ment managers. As large, powerful investors adopt a buy-and-hold strategy with a firm,smaller investors may mimic their investment strategy as a means of sharing some of thevalue provided by the large staff and voting power of the larger owner. The academicliterature has not fully addressed how mimetic isomorphism (Meyer and Rowan, 1977)among owners might affect firm outcomes, although examples in the popular pressindicate this may be an important phenomenon.

Owner Influence and Firm Outcomes/Attributes

In this section, we review the relationship between the influence mechanisms ownersemploy and subsequent firm outcomes and attributes such as performance, strategy, andgovernance processes. It is important to note that not all owner activism is immediatelyapparent. A phone call from an owner to an executive suggesting a new strategy, forexample, is not likely to be visible to outsiders. As a result, a great deal of researchexamines relationships between owners and firm outcomes in broad forms, withoutnecessarily delineating a specific means of influence. The following discussion summa-rizes this research, as indicated by Path B in Figure 1.

Performance. There is some evidence that internal ownership, the presence of outsideblockholders, and dedicated (i.e. long-term) agent owners all lead to better firm perfor-mance. The rationale for each of these relationships is different. Insider equity inducesmanagers to focus on performance ( Jensen and Meckling, 1976). While blockholdersgain larger stakes in the firm, they become increasingly interested in the effectiveness ofwealth-creating activities (Mikkelson and Ruback, 1985). Agent owners have greaterleverage in pressuring firms to focus on performance-enhancing activities because con-centrated holdings provide them with additional voting shares and greater bargainingpower with managers (Pound, 1988).

However, empirical evidence for owner influence on firm performance is mixed(Bainbridge, 2003; Dalton et al., 2003). This may be due in part to the preponderanceof empirical studies that amalgamate diverse forms of owners despite important dif-ferences in their investment horizons and ability to affect firm actions. Some scholarshave uncovered significant relationships by grouping together owners that representparticular types of clients (e.g. Hoskisson et al., 2002; Ramaswamy et al., 2002). In this




sense, the influence of agent owners on firm performance appears to exist in the pres-ence of moderator variables (Grinstein and Michaely, 2005; Ramaswamy, 2001; Vil-lalonga and Amit, 2006). The same is likely to be true for other forms of ownership,which explains why meta-analyses often point to the presence of moderators (Daltonet al., 2003).

Besides maintaining positive earnings, firms also have a responsibility to their com-munities, employees, customers, and other stakeholders (Graves and Waddock, 1994).Recent research on the influence of owners on corporate social performance (CSP) showsthat mutual funds are negatively associated with CSP whereas pension funds are posi-tively associated ( Johnson and Greening, 1999). Neubaum and Zahra (2006) confirmedthese results, finding that long-term and short-term agent owners maintain differingviews about CSP. These studies show initial promise that owners have an importantbearing on CSP, but scholars have yet to develop a comprehensive body of empiricalresearch examining other forms of ownership or specific aspects of CSP, such asemployee wages or the natural environment ( Yoshikawa et al., 2005).

Strategy. Perhaps the most highly investigated link between owners and decisions withinthe firm involves the examination of owner influence on innovation. Baysinger et al.(1991) initially found a positive relationship between ownership concentration and cor-porate R&D spending. Later research found that professional investment funds preferexternal innovation whereas pension funds prefer internal innovation (Hoskisson et al.,2002). David et al. (2001) added the notion that owners affect R&D through the mediumof activism. One important distinction that this line of research has discovered is thatpressure-resistant institutions are positively associated with innovation, but pressure-sensitive institutions are negatively associated with innovation (Kochhar and David,1996). Bushee (1998) captured this difference more explicitly, finding that transientowners are more likely to pressure firms to cut R&D spending to meet short-termearnings goals.

Research on the relationship between a firm’s ownership structure and corporatediversification has also received considerable attention. Financial economists often cite astudy by Amihud and Lev (1981) to show that the absence of large and powerfulshareholders results in greater unrelated product diversification. Strategic managementresearchers, however, questioned these findings (Boyd et al., 2005). Lane et al. (1998), forexample, found that ownership concentration was not related to product diversification.Ramaswamy et al. (2002) found that pressure-sensitive owners are associated with unre-lated product diversification whereas the association is negative for pressure-resistantowners. Firm owners also appear to influence international diversification (Tihanyi andEllstrand, 1998). In contrast to product diversification, all types of institutional ownersgenerally support international diversification (George et al., 2005), but for differentreasons (Tihanyi et al., 2003).

Strategic management scholars also have examined owner influence on a number ofother firm-level outcomes. For example, early research showed that institutional ownersfoster restructuring activity in order to create more efficient organizations (Bethel andLiebeskind, 1993). Ownership structure also influences a firm’s acquisition strategies,with higher internal equity fostering less risky acquisitions but blockholders and certain



institutional owners pressing for higher risk acquisitions (Wright et al., 1996, 2002).Because research has demonstrated that owners shape the incentives of managers whomake competitive decisions, scholars are also beginning to consider the influence ofownership forms on competitive activity between firms. Initial findings suggest thatowners may affect both vertical relationships (i.e. upstream suppliers and downstreambuyers) and horizontal relationships (i.e. competitive behaviour between firms) (Vroomand Gimeno, 2007).

Governance processes. A large body of research considers the effects of specific forms ofownership on other governance structures. For example, research and anecdotal evi-dence suggests that ownership structure influences board independence as well as theimplementation of a variety of governance policies related to issues such as classifiedboards, greenmail, directors’ duties, and golden parachutes (Bushee et al., 2004). Large,activist shareholders are often successful in their efforts to induce governance changes,but there is little evidence for the systematic effectiveness of those changes in addingvalue to firms. Others have found more complex relationships between owners andboards wherein they interact in their influence on firm strategies. For example, Tihanyiet al. (2003) found that international diversification was favoured by professional invest-ment funds with outside board members and by pension funds with inside boardmembers. This indicates that particular types of board members may represent theinterests of some shareholders better than others.

Executive compensation is also a function of ownership structure (Hartzell and Starks,2003). In firms with some family ownership, Gomez-Mejia et al. (2003) found that CEOfamily ties have a negative impact on their pay. However, CEO pay and job status is alsomore secure because the emotional, familial ties of family owners makes them poormonitors of executive actions. These authors also found that the presence of institutionalinvestors compensates for poor monitoring because institutional investors take an activepolicing role. Others have provided a more fine-grained understanding of the role ofownership structure on compensation, finding that pressure-resistant owners and outsideblockholders negatively influence CEO pay (Almazan et al., 2005; David et al., 1998).The motivation and ability of investors to monitor executive compensation may becompromised depending on what other firms simultaneously reside in their portfolio ofholdings (Dharwadkar et al., 2008). Research on ownership structure and executivecompensation overlaps in the literature on equity-based incentives (Core et al., 2003).Firms use ownership as a means of compensation with a view towards linking changes inexecutive wealth directly to changes in stock price.

Ownership structure also affects the market for corporate control. Ownership and themarket for corporate control are highly interrelated, because the market will not correctfor poor management until stock price declines. For the market for corporate control towork effectively, managerial teams must essentially compete to control specific corporateassets, but the ownership structure of firms that are supposed to serve as the disciplinar-ian in the market for corporate control also comes into play. For example, Wright et al.’s(1996) finding that managers with more equity in their own firm pursue less riskyacquisition strategies suggests that such managerial teams will be hindered in their abilityto compete in the market for corporate control. Similarly, there is some evidence that




family-owned firms are insulated from the market for corporate control (Villalonga andAmit, 2006). Public firms also attempt to insulate themselves from the market forcorporate control by implementing takeover defences, but many owners recognize thesetactics and pressure firms in which they invest not to adopt such defences (Kabir et al.,1997). For this reason, effectiveness of the market for corporate control is often criticizedby policymakers and academics (Hitt et al., 1996). In fact, there is even recent evidencethat anti-takeover provisions may protect managers from short-term thinking and thuspotentially improve shareholder wealth (Turk et al., 2007).

Firm Outcomes/Attributes and Ownership Structure

The third and final aspect of our model suggests that potential owners make investmentdecisions based on information about the firm’s outcomes and attributes. This researchis represented by Path C in Figure 1. Research based on signalling theory (Spence, 1973)underscores the influence of these attributes on ownership decisions. Potential ownersface a great deal of information asymmetry regarding the future prospects of firms inwhich they might invest. According to the signalling perspective, firms signal potentialowners to indicate firm quality, legitimacy, top management team quality, or strategicdirection. Signalling theory proposes that these signals are particularly effective whenthey are costly and difficult to imitate (Certo, 2003).

Scholars in economics and finance have used signalling theory to better understandhow firm attributes may influence investor decision making. Ross (1977), for example,examined debt as a signal of firm quality. Presumably, investors perceive that firms withhigher debt levels demonstrate firm quality by inferring that such firms will earn enoughincome over time to repay their debt. Similarly, Bhattacharya (1979) proposed that firmdividends, which are difficult to reduce or eliminate, serve as signals of firm quality.Dividends serve as a costly signal because only high quality firms will earn enough moneyin the future to issue large dividends. Other research indicates that a variety of firmcharacteristics may influence ownership decisions. For example, the equity held by topexecutives serves as one signal of firm quality, as executives will buy stock when theyforecast high levels of future performance and sell stock when the firm’s prospects are notas high (Busenitz et al., 2005; Filatotchev and Bishop, 2002). Other signals that firms mayuse to communicate desirable characteristics to potential shareholders include incentive-based executive compensation structures (Core et al., 1999), inter-organizational ties(Gulati and Higgins, 2003), top management team and board prestige (Lester et al.,2006), and internal equity holdings (Goranova et al., 2007).

Much of the research examining the effects of firm attributes on ownership decisionsoccurs in the context of studying firms undertaking initial public offerings (IPOs). As theIPO process transitions privately-held firms to public equity markets, the context pro-vides a natural setting in which to examine investor decision making. Research indicates,for example, that the firm’s human capital may serve as a signal of firm quality. Certo(2003) suggests that investors may use information about boards of directors to makeinvestment decisions. As prestigious outsiders join an IPO firm’s board, investors maydeduce that the firm is legitimate enough to attract outsiders who are concerned withprotecting their reputations. Additional research using similar logic indicates that aspects



of the firm’s top management team also influence investor decision making (Cohen andDean, 2005; Higgins and Gulati, 2003; Jain and Tabak, 2008).

Other research in the IPO context examines the extent to which relationships withthird parties influence investor decision making. According to this point of view, rela-tionships with prestigious third parties may help to ‘certify’ firm quality. Researchindicates, for example, that relationships with prestigious venture capitalists or invest-ment bankers may influence investor decision making (Elitzur and Gavious, 2003;Megginson and Weiss, 1991). Complementing these studies, other research suggests thatrelationships with prestigious strategic alliance partners influence investor perceptions offirm quality (Chang, 2004; Park and Mezias, 2005). Compared to paths A and B, theresearch examining path C is less developed. Nonetheless, firms actively use differentfirm outcomes and attributes, such as debt levels, dividend issues, human capital, andsocial relationships, to engage future owners and influence investor decision making.

EMERGING ISSUES

The landscape of firm ownership has seen dramatic change in recent decades. In theUSA and UK, concentrated ownership has shifted from blockholders to more fraction-ated agent owners, new forms of owners such as hedge funds have dominated theheadlines, state and foreign ownership of domestic enterprises have become increasinglycommon, and managers are more acutely aware of, and beholden to, their ownershipstructures. We discuss a number of such emerging issues against the backdrop of ourbasic model and describe avenues for research that the scholarly community mightconsider to address these issues. While the concepts we cover in this section are at thecore of general governance research, the developing nature of owner behaviour andgovernance systems vary substantially around the world, which Johnson et al. (2010)discuss in their article.

Emerging Issues in Ownership Structure and Owner Influence

Ownership of US and UK firms is becoming increasingly concentrated in the hands ofagent-owners, which in some ways contradicts what we know about agency theory,which is based on ownership diffusion. Via activism, agent-owners are taking backpowers that seemingly were delegated strictly to managers in traditional agency theory.Furthermore, scholars are beginning to recognize the importance of differing interestsamong these owners. A growing body of literature on ownership heterogeneity revealsthat some agent-owners are short-term oriented because their annual portfolio turnoversrange as high as 60–80 per cent (Bushee, 1998). Hedge fund owners even take positionsexpecting the stock price to go down, thus adopting a contrary view of ownership; in sodoing, they seek to gain wealth through ‘shorting’ firms by betting that firms will actuallyreduce the wealth of other shareholders (Kahan and Rock, 2009). Owner heterogeneityis also changing as foreign institutional investors and state owned funds increasinglyinvest in a wide range of developed economy firms (Aggarwal et al., 2005). For instance,recent increases in state ownership attempting to rescue firms, and even industries, haveraised questions about the nature and extent of their involvement in the strategic




decisions of those firms. Similarly, Chinese and Middle East sovereign wealth funds areinvesting in the USA and other developed economies through acquisition and minoritypositions (Kaplan and Teslik, 2007). More research is needed to examine what firmstrategies this increasing variety of agent-owners will support. Table II presents a rangeof research questions that scholars might consider with respect to the changing nature ofownership structures and how this new breed of owners might affect the firms in whichthey invest.

Heterogeneity in ownership types suggests that we need new theoretical developmentto guide the relationship between increasingly diverse and dynamic ownership structuresand the strategic behaviours they encourage. An emerging theory in this area is multipleagency theory, where agent-owners are examined in relation to the particular interests oftheir ultimate shareholders and how they compare, contrast, and conflict with otheragent-owners (Arthurs et al., 2008). Recent work by Connelly et al. (in press) reveals thatowners with differing interests not only affect firm strategies differently but also interactwith each other in the way they influence firms to engage, or not engage, in competitiveactivity. These authors also capture the changing nature of owner interests over time,suggesting that owner interests and owner influence are not static propositions. Brutonet al. (2009) add to these ideas, finding that not only are the varied interests of agent-owners and private equity investors (e.g. business angels and venture capitalists) signifi-

Table II. Emerging issues in ownership structure and owner influence

Area of study Key research questions for future study

Inside ownershipand restructuring

How does disparity of ownership among members of the top management teamaffect organizational structure and change?How is firm expansion influenced by board members that own large shares of thefirm and are also on the boards of potential competitors and/or acquisition targets?

Inside ownershipand activism

Does increased inside ownership change executive responsiveness to the pressures ofactivist investors?How do ownership differences between the board and the top management teamaffect the ability of the board to represent other shareholders?

Inside ownershipand buy-and-hold

How does inside ownership influence the extent to which executives discloseinformation to their investment base?How do owners interpret multiple, potentially conflicting, signals from insideowners?

Outside ownershipand restructuring

How does State ownership affect the way firms organize themselves for thecompetitive marketplace?How do the interests of private equity investors (e.g. business angels and venturecapitalists) clash with those of public investors after an IPO?

Outside ownershipand activism

Do agent owners effectively represent the interests of their clients?To what extent to owners work together, or in competition with each other, toinfluence firms in their portfolio?

Outside ownershipand buy-and-hold

How do long term investors help firms manage their resource dependencies?What are the long-term implications of foreign ownership and sovereign wealthfunds?



cantly different, but interests also vary across institutional settings. Johnson et al. (2010)in this issue provide a more detailed account of these institutional differences; theirinternational analysis supports our conclusion that more studies are needed to examinevaried owner interests and to provide more complex and dynamic theoretical frames thataccount for the changing nature of ownership structures. Furthermore, future researchmight examine differences in context between more developed economies such as theUSA and UK. For example, historical research in the UK focuses on ‘gentlemanlycapitalism’, which helped to manage and spread the power of the British empire(Webster, 2006). Remnants of this approach remain today and have led to firm gover-nance polices which are more informal for firms headquartered in the UK as comparedto US firms, especially under the Sarbanes–Oxley regime in the USA (see the CombinedCode of Corporate Governance, 2003)

Multiple agency theory also applies to the case of venture capital syndicates (Lockettand Wright, 2001). Recent work on venture capitalists highlights heterogeneity inventure capitalist specialization. De Clercq and Dimov (2008), for instance, suggest thatsome venture capitalists specialize in internal knowledge (e.g. industry), whereas othersspecialize in external knowledge through inter-firm relationships. Importantly, thisresearch indicates that venture capitalist specializations have alternative influences onportfolio firm performance. In fact, multiple venture capitalists may even work together,sharing information, capital contributions, and monitoring efforts, to improve firmperformance (De Clercq et al., 2008). Despite this sharing, Lockett and Wright (2001)highlight potential agency costs that can arise from the presence of multiple investors inthese types of syndicates.

Emerging Issues in Owner Influence and Firm Outcomes/Attributes

The governance efforts of owners are often jointly present and interact with the effectsof other forms of governance. However, we know very little about what happens togovernance after restructuring efforts. Hoskisson and Turk (1990) discuss this issue, butthere remains a dearth of empirical research exploring these relationships or examiningthe extent to which forms of governance are reformed after ownership changes hands.For example, Haynes et al. (2007) begin to address this subject by examining theimpact of refocusing on executive compensation practices. An opportunity exists there-fore to expand our understanding of the interaction of governance structures by explor-ing the consequences of major ownership change. Given increasing managerialattention to ownership structures, resource-dependence theory (RDT) may provide anappropriate theoretical lens through which to better understand principal–agent rela-tionships (Pfeffer and Salancik, 1978). RDT provides a useful perspective for under-standing how managers might supervise an increased dependence on agent-ownercapital providers. RDT generally incorporates a wide array of constituencies (e.g. sup-pliers, customers, government entities, and special interest groups) as compared toagency theory’s focus on shareholders. Nonetheless, as sources of capital, owners rep-resent a significant group of resource providers and could potentially serve as an impor-tant source of uncertainty (or uncertainty-reducing information) and interference (orstrategic assistance).




This is especially true because agent-owners have different interests, which can resultin competing demands on managers (Bushee, 2001; Hoskisson et al., 2002). Whileagency theory is based on issues of efficiency, RDT assumes that issues of power takeprecedence in establishing governance arrangements. Accordingly, managers of firmsthat are experiencing conflicting pressures might undertake to influence owners in a waythat will be supportive of the firm’s strategic position, independent of efficiency consid-erations. This would lead to research focused on how managers influence owners,especially agent owners, in a range of activities, including: less aggressive cooperativestrategies such as ingratiation, moderate strategies such as monitoring through an inves-tor relations department, and more aggressive influence strategies such as appeasementof particular blockholders (Marcus, 2005; Westphal and Bednar, 2008). For example, topexecutives may employ strategies to ‘recruit’ certain types of owners that will allow formodification or mollification of the firm’s owners in order to lobby them in a way thatwould lessen dependence (Bushee, 2004).

Agency theory contains an explicit assumption of potential managerial opportunism.However, an important topic in the future will likely be owner opportunism. As ownersbecome more proactive, they may undertake actions that benefit themselves at theexpense of managers and the long-term health of the firm. For example, some share-holders may be so concerned with short-term, quarterly results that they intentionallyvote against and discourage long-term projects that may be necessary for the firm to gainstrategic competitive advantage (Connelly et al. in press). White and Hoskisson (2009)suggest that one of the difficulties in fashioning effective models of agency relationshipsmay be that researchers have not fully considered the possibility that principals may actopportunistically towards agents. We further suggest that many observed corporategovernance outcomes may, at least partially, have their roots in protecting agents againstunwarranted principal opportunism, such as short selling. We review these and otherfuture research questions pertaining to owner influence on firm outcomes/attributes inTable III.

Emerging Issues in Firm Outcomes/Attributes and Ownership Structure

Although researchers have established a clear pattern of shareholders influencing arange of firm outcomes and attributes, they have devoted less attention to the possibilityof reverse causality (Chenchuramaiah et al., 2005; Demsetz and Villalonga, 2001).There is some possibility that owners are not necessarily bringing about change in firmsthat they own, but rather investors tend to invest in certain types of firms. For example,research shows a positive relationship between institutional investor ownership and thepresence/absence of certain governance policies, such as classified boards and poisonpill adoption (Gillan and Starks, 2007). Can we necessarily conclude that these investorsactively brought about change in those firms to establish classified boards or not adopta poison pill? Perhaps not, given that the same association would hold true if share-holders were simply more likely to invest in firms that have classified boards and nopoison pills (Bushee et al., 2004). This highlights the need for governance researchers tofurther address the extent to which endogeneity complicates the relationships underinvestigation.



A related concern pertains to how returns of the firm are distributed and appro-priated by various owners. Agency theory, as the dominant perspective in this area,assumes a nexus of contracts ( Jensen and Meckling, 1976), with only one contractualrepresentative, the owners, with an incomplete contract and a claim on residuals of thefirm’s wealth creation process. All other parties in the firm, according to agencytheory, possess a formal contract, so their costs are expensed by the firm. This has ledto the notion of shareholder supremacy, which has become a mantra in schools ofbusiness. However, when owners are not unified in their interests, different types ofowners may claim different types of residuals, based on their assumed property rights.

Table III. Emerging issues in owner influence and firm outcomes/attributes


Activism and firmperformance

How do hedge funds change the way firms assess their performance?What influence does ‘shorting’ have on firm performance?

Activism and firmstrategies

How do activist investors with differing preferences affect firm competitivestrategies?How is managerial attention allocated when they are presented with competingactivist demands?

Activism andgovernanceprocesses

How do third-party advisors (e.g. Glass Lewis, Institutional Shareholder Services)influence the effectiveness of activist investors?To what extent does owner opportunism occur, and who monitors the monitors?

Buy-and-hold andfirm performance

Are long-term investors more concerned about the triple bottom line than othertypes of owners?To what extent do more powerful and influential investors appropriate rents dueto other investors or other stakeholders?

Buy-and-hold andfirm strategies

To what extent do firms learn from the experience of their long-term owners, asthose owners are also invested in other firms?Are the strategic recommendations coming from long-term investors wise?

Buy-and-hold andgovernanceprocesses

How does an institutional investor’s portfolio of firms influence the effectivenessof the market for corporate control?How do institutional differences among foreign owners affect executivecompensation?

Restructuring andfirm performance

What happens to the entrepreneurial orientation of executives following amanagerial buy-out?How do corporate spin-offs diffuse through a cluster of firms with activity insimilar markets?

Restructuring andfirm strategies

How does the entry, or exit, of a single powerful blockholder influence a firm’stactical and strategic competitive activity?How is a firm’s involvement in corporate entrepreneurship affected by aleveraged buy-out?

Restructuring andgovernanceprocesses

How do owner-initiated restructuring activities influence other stakeholders withlong-term stakes?How can governments efficiently privatize firms while still holding executivesaccountable to their new ownership structure?




Some may desire dividends, others stock buy backs or stock value appreciation, andstill others may seek to change the way residual claims are allocated by changing thefirm’s basic strategy.

Going further, if one changes the assumption to incomplete contracting (Aghion andBolton, 1992) rather than formal contracting for all stakeholders (e.g. suppliers, buyers,employees, government entities), then appropriation of the firm’s wealth becomes a moresalient issue (Foss and Foss, 2005). One of the central bodies involved in the appropria-tion process would be the board of directors, because owners lobby to become boardmembers based on their ownership positions (Liang, 2007). As well, in the USA someparties (e.g. commercial banks) are prevented from ownership through legal institutions.Therefore, understanding the criticality of the board in managing the competingdemands of multiple stakeholders, including capital stakeholders, is a key issue for futureresearch. Team production theory (Blair and Stout, 1999) may be useful in this regardinsofar as it explains how a hierarchical body, such as the board of directors, can help tomanage the appropriation process for various stakeholders, including a range of diversecapital holders. Understanding the appropriation process is critical for any propertyrights system because without trust in the appropriation process, not only do marketsbreak down but managers and employees are unwilling to make firm specific investmentsthat are the basis for value creation (Wang and Barney, 2006).

Issues of endogeneity and rent appropriation may be particularly sensitive to thesources of data researchers use to understand the phenomena. Governance research hasoften relied on archival sources of ownership information, making use of corporate proxystatements and surrogate databases such as Value Line, Compac Disclosure, CorporateText, and Spectrum, among others (e.g. Bushee, 2001; Dalton et al., 2003; David et al.,2001). There is considerable discrepancy between these sources, suggesting that not alldata sources will yield similar results in empirical governance research (Anderson andLee, 1997). Further, governance researchers often consider various forms of owners, butdevote little academic attention to understanding owners from a behavioural standpoint.Future research could begin to explore the actions of owners more qualitatively and viasurveys so that we might gain a more nuanced understanding of how owners affect firmsand their managers. This and the other issues described in this sub-section raise anumber of pertinent research questions, which we present in Table IV.

Conclusion

In summary, we have reviewed research and theory on firm ownership using examplesof US and UK firms and studies to foster a better understanding of the relationshipsbetween a firm’s ownership structure, the interests and influences of owners, and howthey affect firm-level outcomes. Evidenced by their presence in the headlines of the Wall

Street Journal, a diverse and rapidly changing range of firm owners has become increas-ingly involved in corporate activity. As scholars and custodians of the theories describingcorporate governance, it behoves us to understand the changes taking place and toconsider how they modify, or even transform, what we know about owners as a form ofcorporate governance.



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Table IV. Emerging issues in firm outcomes/attributes and ownership structure


Performance andinside ownership

How do crisis situations influence insider ownership decisions (i.e. buy/sell)?Do industry characteristics (i.e. munificence, dynamism, complexity) moderate therelationship between past performance and inside ownership?

Performance andoutside ownership

How do firms use the information provided in earnings reports to attractparticular types of investors?How do investors react to firms that are early adopters, majority adopters, andlaggard adopters of corporate social performance initiatives?

Firm strategies andinside ownership

How do risky firm strategies (e.g. R&D expenditures, M&As) influencesubsequent insider ownership decisions?How does international diversification change the role of inside ownership as ameans of alleviating agency concerns?

Firm strategies andoutside ownership

To what extent do internationalization strategies help firms attract foreigninvestors?How does a firm’s balance of tactical and strategic competitive actions influenceits mix of transient and dedicated institutional investors?

Governanceprocesses andinside ownership

What are the ownership implications of pay disparity between the CEO andother members of the top management team?How do an insider’s social relationships, such as board interlocks, influenceinsider ownership?

Governanceprocesses andoutside ownership

How can firms establish legitimacy with investors following a governance failure?What governance practices can a firm implement to avoid being targeted byInstitutional Shareholder Services and other activist coordinating bodies?




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