Why Are Firms With More Managerial Ownership Worth Less?
The relation between managerial ownership and firm value has been empirically assessed repeatedly over the past decades and the consensus is that the relationship between the two is concave. That is, over a low range of ownership there is a positive relation between the two, which turns negative for high values of ownership. The paper at hand takes a fresh look on the issue, in that the authors make use of the largest database of managerial ownership information ever used in the literature, including data for more than 1,800 US publicly listed firms from 1988 to 2015. The database includes a greater number of small firms than previously used in these types of studies.
The relationship between managerial ownership and firm value is negative for almost the entire observed spectrum of ownership. The authors observe a U-shaped relation between managerial ownership and firm value (measured in terms of Tobin’s q). However, the breakpoint is such that the relation is negative for almost the entire observed spectrum of ownership. This stands in contrast to theoretical predictions and previous empirical findings.
The authors provide empirical evidence for a straightforward explanation for this finding, which is that the relation is driven by stock liquidity. The authors posit that managers own more shares at the IPO than they typically want to own over time. As a result, they want to decrease their ownership, but face frictions in doing so. If a firm’s stock is illiquid, it takes time to sell large stakes and doing so may be expensive.
Consequently, the level of managerial ownership of a firm is driven by its past history of liquidity. If the firm’s stock is highly liquid soon after the IPO, managers decrease their ownership so that the firm eventually has low managerial ownership.
The firms whose stock is liquid are typically successful firms, that is they have a high firm value. Hence, more valuable firms tend to have low managerial ownership. Conversely, firms with high managerial ownership are firms whose stock has lacked liquidity. Such firms have not been consistently successful. In line with this reasoning, the authors indeed observe that firms whose managerial ownership fell more rapidly since the IPO have higher firm value.
Conclusively, the relation between managerial ownership and firm value is the outcome of the past history of the firm in terms of liquidity. Past studies have only included large liquid firms, for which liquidity is of less importance. This is why the authors, who include a greater number of small firms in their sample than previous studies, find different results.
The relation between granting managers a higher ownership stake and firm success needs to be reconsidered. Previous studies show a concave relation between managerial ownership and firm value. This does not hold for small firms, where managerial ownership is influenced by liquidity constraints. The frictions that impede adjustments in managerial ownership have to be taken into account in theories of firm value and managerial ownership.