A note on the separation of ownership from control.
The "separation of ownership from control" is frequently taken to reflect a major weakness in the corporate structure of the U.S. economy. For it is understood to imply a loss of effective control by stockholders over managerial decisions that affect the value of their wealth. The underlying cause of this "separation" of ownership from control is alleged to lie in the dispersion of stockholding which, combined with management advantages in a proxy fight, leads to a rise in the power of managers and their reduced dependence on the owners. At the same time, the market power of the modern corporation, which depends on whether a segment of its demand curve lies above the average opportunity cost schedule, implies that the firm can earn profits in excess of its survival requirements. It is the existence of this market power of the firm that makes the manager's independence from the owners effective. The managers find it possible to substitute away from potential profits to gain other desiderata (managers' interests). Those expenditures are supposed to reduce stockholders gains while raising the managers' total compensation via the consumption of specific utility-yielding goods (e.g. liberal expense accounts) and activities (e.g. self-financed investments in excess of the owners' time preference).
Clearly, the "separation" thesis implies that "the rule of management" results from the cost to the owners of detecting and policing managerial decisions, and of enforcing wealth maximizing behavior. But that is just about all the "separation" thesis as advanced by Berle, means and others really says(1). It offers no refutable implications and is consistent with any outcome, e.g. all sorts and degrees of exploitation of stockholders by the firm's management. Alchian wrote: " ... demonstration of greater dispersion of stockholding, along with our proxy system, does not establish that bearing-of-value consequences have been separated from the effective control of the decision maker, nor that the wealth of the stockholders is less well guarded(2)."
A meaningful treatment of the "separation" thesis calls for the development of behavioral implications subject to refutation by facts. To accomplish this objective the analysis must identify circumstances and factors that affect both the managers' set of opportunity choices as well as their penalty-reward structures (trade-offs). The purpose of this paper is to make a step in this direction; that is, to formulate the "separation" thesis in such a way to make its implications testable.
The development of refutable implications of the "separation" thesis presupposes that we can identify the factors that affect the constraints (transaction costs) on the power of managers to do what they want, and that we can identify the effects of the various property rights assignments in resources on transaction costs and economic incentives. One important factor in a private property capitalist economy that could be expected to affect transaction costs in a private non-regulated firm is the linkage between the managerial decision and a possible reaction of the stock market, and back from the stock market to a possible reaction of stockholders. The fact that the stock market immediately and readily evaluates the expected future value consequences of the current managerial policies can be taken to result in a significant reduction in the owners' costs of detecting the behavior of their managers. Of course, it is the evaluation per se rather than its accuracy that is an important factor affecting the managers' preception of transaction costs.
Insofar as stock prices reflect the present value of the expected future consequences of the current managerial policies the presumed implication of the "separation" thesis is as follows: we should expect to find a negative relationship between the dispersion of stockholding and the owners' gains in wealth; that is, we should expect a lower bid price for stocks of corporations with dispersed ownership. If no such relationship is found, the thesis that the behavior of managers in corporations with the dispersed ownership is less consistent with stockholders' interests could at least be seriously questioned.
In this section of the paper we shall attempt to evaluate the question: "Do dispersed ownership corporations have lower rates of growth of stockholders' wealth (allowing for dividends and capital value growth) than less dispersed ownership firms?(3)". For lack of better data we shall use the percentage of the firm's stock held by institutions as a proxy for dispersion. We assume that institutions are more likely to incur the cost of detecting and policing managerial decisions, and of enforcing wealth maximizing behavior. Thus, an increase in the percentage of the firm's stock held by institutions will be taken to imply a reduction in the dispersion of ownership or an increase in the consolidation of ownership.
The rate of growth of stockholders' wealth is defined as follows:
|R.sub.t~ = |E.sub.t~ + |P.sub.t~ - |P.sub.t-1~/|P.sub.t-1~ X 100, (1)
where |E.sub.t~ = annual dividend per share
|P.sub.t~ = stock price at the end of period t
|P.sub.t-1~ = stock price at the beginning of period t.
Then, we assume that |R.sub.t~ is a linear function of the percentage of total stocks held by institutions and at the end of period t(|C.sub.t~), and the ratio of long-term debt to the market value of the firm's common stocks (|D.sub.t~).
|R.sub.t~ = |a.sub.0~ + |a.sub.1~|C.sub.t~ + |a.sub.2~|D.sub.t~ + U (2)
where U is a random error term, |a.sub.0~ is a constant, and |a.sub.1~ and |a.sub.2~ are marginal rates of return with respect to (C) and (D).
In order to keep the analysis confined to a relatively homogeneous group, we have selected thirty-eight firms in the chemical industry whose shares are actively traded on the national and/or regional stock exchanges. The complete list of firms is given in Appendix I. Data are collected from the Standard and Poor's Stock Guide(4) and cover the period 1962-1972.
The equation (2) is tested in two ways. First, the equation is tested with the intra-firm data and results are summarized in Table 1. Second, the model is tested with the inter-firm data and results for ten years are listed in Table 2. These two tables list values of coefficients |a.sub.0~, |a.sub.1~, and |a.sub.2~. The values in parentheses beneath the coefficients are their t-values, |R.sup.2~ denotes the coefficient of determination, |Mathematical Expression Omitted~ is the coefficient adjusted for degrees of freedom while the F-ratio tests the over-all fit.
Table 1 shows that statistical fit is significant (at 5 per cent level of significance) only for three firms. Out of these three firms only two show a statistically significant positive coefficient. Furthermore, only four firms from the sample of thirty-eight enterprises show a statistically significant positive relationship between the consolidation of stockholding (as defined by our proxy) and the owners' gains in wealth. The results for the remaining thirty-four firms suggest no such relationship. The coefficient of debt ratio, that is, |a.sub.2~ is negative for thirty firms out of thirty-eight firms. The coefficient |a.sub.2~ is statistically insignificant for all the eight enterprises in which this has a positive value. On the other hand, out of thirty negative cases, the coefficient is statistically significant at the 5 per cent level of significance for six cases.
TABULAR DATA OMITTED
The inter-firm analysis in Table 2 conveys a similar conclusion. As it is evident from this table, statistical fit is significant (at the 5 per cent level of significance) only for the year 1971. The results for the remaining nine years show that the relationship between the dispersion of stockholding and the owners' gains in wealth is not only statistically insignificant but the sign has no systematic pattern. The coefficient of debt variable is negative for eight years and statistically significant for two years.
It may be pointed out that we have also tested the above model with one, two and three years lags in rate of return variables. These results are similar to those presented in Tables 1 and 2.
TABULAR DATA OMITTED
The performance of thirty-eight firms in the chemical industry over the period of 1962-1972 shows no evidence that the wealth of stockholders in corporations with the dispersed stock ownership is not well guarded. Admittedly, our test is limited in both the scope as well as in coverage. Yet, it tests a presumed implication of the "separation" thesis, and hopefully will have the way for further empirical works. Indeed, it is important to establish the presumed implications of the "separation" thesis, otherwise the increasing dispersion of stockholding in the last thirty years would have to be attributed to basic irrationality of private investors.
Professor Rajindar K. Koshal, Professor of Economics, and Mr. S. Pejovich are at Ohio University, Athens, Ohio, U.S.A.
1 See A. Berle, Power Without Property, New York: Harcourt, Brace and World, 1959, especially chapter 2; and A. Berle and J. Means, The Modern Corporation and Private Property, New York: Harcourt, Brace and World, 1968, especially chapters 4-5.
2 A. Alchian, "Corporate Management and Property Rights", in The Economics of Property Rights (E. Furubotn and S. Pejovich, eds.), Cambridge: Ballinger Publishing Company, 1974, p. 136.
3 Ibid., p. 141.
4 Standard and Poor's Corporation, Stock Guide, New York, 1963-1972.
List of Firms Included in the Analysis
1. Air Products & Chemical 2. Allied Chemical 3. American Cyanamid 4. Beta Labs 5. Big Three Industries 6. Cabot Corporation 7. Celanese Corporation 8. Chemetron Corporation 9. Commercial Colvents 10. Crompton & Knowles 11. Detrex Chemical Industry 12. Diamond Crystal Salt 13. Dow Chemical 14. Du Pont 15. Economics Labs 16. FNC Corporation 17. Foster Grant Company 18. Freeport Minerals 19. Fuller 20. Grace Company 21. Hercules, Inc. 22. Hunt Chemical 23. International Mineral & Chemical 24. Koppers Company 25. Mollinckrodt Chemical 26. Monsanto Company 27. Nalco Chemical Company 28. National Chemsearch 29. National Distiller & Chemical 30. Olin Corporation 31. Pennwalt Corporation 32. Products Research & Chemical 33. Reichhold Chemical 34. Richardson Company 35. Rohm & Hass Company 36. Steuffer Chemical 37. Union Carbide Corporation 38. Witco Chemical
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|Title Annotation:||Control; includes appendix|
|Author:||Koshal, R.K.; Pejovich, S.|
|Publication:||Management International Review|
|Date:||Jan 1, 1992|
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