Corporate Equity Ownership and Product-Market Relationships

Abstract

This paper investigates an unexplored dimension of block-equity ownership: benefits in product-market relationships between corporations. We find significant increases in investment and operating performance for firms that have product-market relationships with their corporate owners. We also find that the size of equity stakes is positively related to measures of asset specificity and growth options, especially when firms can fund subsequent investment with internal funds. Investment of target firms with business relationships with their corporate owners also significantly increases with Tobin's q following the block equity purchases. We find a strong association of investment with Tobin's q for firms in which there is repeated interaction through supply and distribution agreements between the firm and its equity owner.

Our evidence indicates that benefits in product-market relationships are an important motivation for corporate equity ownership. The evidence is consistent with the view that an equity position by an outside corporation is important in aligning incentives between contracting firms to expand joint investment opportunities and reduce the costs of generating and maintaining business agreements and alliances.

JEL Classification: G32, L11, L22