Blockholders: shared and private benefits of control

Minority shareholders face a free rider problem to afford management monitoring, an expensive and time consuming activity necessary to prevent managers from behaving opportunistically. In the case of blockholders, the size of their stake makes it worthwhile to dedicate resources to monitoring and getting involved with corporate decision making. If the blockholders’ stake is

big enough, the shareholder may be represented at the board of directors as proprietary director. Although stock market regulations will prevent him from trading during certain periods -i.e. prior to financial or corporate announcements-, the presence of a proprietary director will allow the investor to access management and corporate information frequently, enhancing company monitoring and resulting in an informed view on the company. Blockholders that are also proprietary directors partially compensate for the agency problems derived from the separation of ownership and control (Shleifer and Vishny, 1986) (Agrawal and Mandelker, 1990) (Chung et al., 2002).

Blockholders are shareholders with a relevant stake in the firm that allows them to gather more information on the firm than minority shareholders (Edmans & Manso, 2011). An insider -i.e. a manager or director- can also accumulate a block of shares, but stock market regulation will prevent him from benefiting from this informational advantage, so this definition focus on outside blockholders that can build and benefit from an informational advantage. There is no empirical threshold for the stake considered a block, but based on existing regulation, most research considers the presence of blockholders on stakes beyond 5%.

The size of blockholders’ stakes grants them access to the firm’s management, provides incentives to afford detailed and expensive analysis of corporate information and may also lead to decision-making power derived from the political rights of his stake -directors nomination and decisions adopted at the shareholders meeting-. When investors forgo the benefits of diversification and concentrate capital in a block they pursue both shared and private benefits of control (Holderness, 2003).

Shared benefits of control derive from the fact that the higher the stake, the higher is total risk assumed by the investor, who will also have higher incentives for monitoring and increasing firm value. The increase in firm value that results from blockholders’ intervention is shared by all shareholders (Claessens et al., 2002; Shleifer & Vishny, 1986).

141 But blockholders may enjoy advantages that are not shared with minority investors -private benefits of control-. This would be the case of a blockholder who is a firm that enjoy synergies with the company where it holds the stake or, on a more negative note, if the blockholder is diverting corporate resources for its private consumption as in the “tunneling” or transferring of funds out of the firm. In this case, instead of the traditional “principal-agent” conflict between managers and shareholders, there is a “principal-principal” conflict between blockholders and minority shareholders, particularly if the blockholder is a controlling shareholder (Young et al., 2008). Controlling shareholders are blockholders with the capacity to exert influence on the company management, not necessarily with a majority stake. We will refer to “controlling shareholders” as those blockholders with over 20% of capital, in line with (La-Porta et al., 1999).

The potential abuse by controlling shareholders can be performed by direct ownership or by control enhancing mechanisms designed to achieve high control rights without the equivalent proportion of ownership -cash flow rights-, such as the use of pyramids and dual class shares - shares with differential voting rights-. In this vein Claessens et al. (2002) found that the difference between ownership -cash-flow rights- and political rights is negatively related to corporate valuation, suggesting that entrenched shareholders may exert their influence to extract rents from the firm. Nguyen Thi (2018) found evidence of firm value decreasing as the controlling shareholder increases his stake -reflecting a positive relationship between power and expropriation-, until 45% of capital is reached: from this point onwards, the controlling shareholder has the power to expropriate minority shareholders but his incentives decrease due to private gains being lower.

Therefore, the impact of blockholders presence on firm value will depend on the trade-off between share benefits of control, enjoyed by all shareholders, and those private benefits of control that are detrimental to minority investors. A bigger stake in the company increases the

incentives to monitor management and reduce agency problems, unless the stake becomes big enough to generate expropriation incentives: the blockholder may use his political rights to influence the firm towards the adoption of decision that are in his interest, rather than the firm’s. This is consistent with the results of Park et al. (2008), who find evidence of a positive market reaction to outside block formation after removing from their sample majority control blocks. In the same line, Schnatterly et al. (2008) argue that large institutional owners have an informational advantage in terms of access to management, economies of scale in the acquisition of information due to the size of their investments and expertise in processing financial information, improving their monitoring capabilities.

Lastly there is evidence of a learning curve for blockholders, as shown by Kang et al. (2018): the experience obtained from holding multiple blocks in different companies reduces monitoring costs and improves the blockholders capabilities. Better monitoring is achieved when investors have block holdings in several companies of the same industry, when they keep them over long periods of time or when they have prior experience in firm intervention.