Substitutability vs. Complementarity Among Corporate Governance Mechanisms: A Simultaneous Equation Approach

Abstract

Emerging economies are typically characterized by weak shareholders' protection and highly concentrated ownership structures which are relatively stable over time. With concentrated ownership, the conflict of interests shifts from the principal-agent problem to a dominant shareholders-minority shareholders focus. The conflict of interests between shareholders is characterized as the potential for asset diversion from the firm to dominant shareholders, reducing overall firm value. I analyze the effects of the discrepancy between voting rights and cash-flow rights for dominant shareholders and other governance mechanisms on firm value. Departing from previous literature I propose a detailed analysis of the identity of each shareholder. Voting rights and cash-flow rights are therefore aggregated only at the core of identified business groups. To minimize negative effects of ownership concentration on firm value, Latin-American firms resort to a number of different corporate governance mechanisms that are complements rather than substitutes. I find that while firm value do suffer market discounts due to the separation of ownership and control, blockholders detached from dominant shareholders assume monitoring roles and help curtailing asset expropriation. Although multiple-class shares are common in some countries, firms with a single class of shares are highly valued by market participants. I also find that Latin-American firms are underleveraged and that the benefits and costs imposed by the passing of the Sarbanes-Oxley act in year 2002 have already been incorporate in other governance mechanisms. Beyond the potential large private benefits of control, concentrated ownership may be prescribed in dynamic competitive environments. I explore the motivations for outside investors to take large stakes to finance the firm's activities, facing expropriation, illiquidity and under diversification risks.

Keywords: Firm performance, emerging markets, simultaneous equations

JEL Classification: G15, G32, G34