Concentrated Shareholders as Substitutes for Outside Analysts

16 Pages Posted: 3 Nov 2008

See all articles by Sanjiv Sabherwal

Sanjiv Sabherwal

University of Texas at Arlington - Department of Finance and Real Estate

Stephen D. Smith

affiliation not provided to SSRN

Abstract

We contend that there is a governance substitution effect, with concentrated shareholders substituting for the monitoring activities of analysts. Our results are consistent with the opinion that regulators need not fear large shareholders. This is especially applicable to large outside shareholders as we find that the economic effect of concentrated outsider shareholdings is quite strong and greater than that of concentrated insider shareholdings. Our results support the argument that an outsider with a larger stake in a firm is more likely to produce its own in-house information for the monitoring of the firm's managers and avoid both the cost and moral hazard problems associated with analysts. The results also support the argument that if senior managers hold large stakes in the firm, there is a greater likelihood that managerial incentives will be aligned with those of other shareholders. Using a clean ownership dataset with a sample of 3,115 firm-year observations for U.S. firms and regression techniques that address any potential endogeneity, we find that analyst following is negatively related to the concentration of outsider and insider shareholdings. We find similar relations for changes in analyst following and changes in ownership concentration. We examine the relationship of concentration of shareholdings with the number of financial analysts following a firm to see if concentrated shareholders substitute for the monitoring activities of analysts. We examine the relationship of concentration of shareholdings with the number of financial analysts following a firm to see if concentrated shareholders substitute for the monitoring activities of analysts. Using a clean ownership dataset with a sample of 3,115 firm-year observations for U.S. firms and regression techniques that address any potential endogeneity, we find that analyst following is negatively related to the concentration of outsider and insider shareholdings. We find similar relations for changes in analyst following and changes in ownership concentration. Our results support the argument that an outsider with a larger stake in a firm is more likely to produce its own in-house information for the monitoring of the firm's managers and avoid both the cost and moral hazard problems associated with analysts. The results also support the argument that if senior managers hold large stakes in the firm, there is a greater likelihood that managerial incentives will be aligned with those of other shareholders. We contend that there is a governance substitution effect, with concentrated shareholders substituting for the monitoring activities of analysts. Our results are consistent with the opinion that regulators need not fear large shareholders. This is especially applicable to large outside shareholders as we find that the economic effect of concentrated outsider shareholdings is quite strong and greater than that of concentrated insider shareholdings.

Suggested Citation

Sabherwal, Sanjiv and Smith, Stephen D., Concentrated Shareholders as Substitutes for Outside Analysts. Corporate Governance: An International Review, Vol. 16, Issue 6, pp. 562-577, November 2008, Available at SSRN: https://ssrn.com/abstract=1292001 or http://dx.doi.org/10.1111/j.1467-8683.2008.00706.x

Sanjiv Sabherwal (Contact Author)

University of Texas at Arlington - Department of Finance and Real Estate ( email )

Box 19449 UTA
Arlington, TX 76019
United States
817-272-3705 (Phone)
817-272-2252 (Fax)

Stephen D. Smith

affiliation not provided to SSRN ( email )

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