Over the past few decades, the ownership structure of American firms has undergone a significant transformation. Gone are the days of dispersed ownership, where most firms were owned by thousands of individuals directly investing their savings in the stock exchange. Instead, we now have a complex web of institutional investors and powerful individual or family shareholders who hold concentrated ownership and decision-making power. This trend includes double voting schemes such as the ones used by Alphabet Inc. (Google) or Meta (Facebook) and other mechanisms that provide extra voting power to a few shareholders. As a result, there is a growing need to reexamine corporate governance through a new lens. In particular, we must find ways to better protect minority shareholders, including everyday individuals, from the potentially harmful effects of concentrated ownership. This is a critical issue that requires urgent attention as we navigate the new realities of corporate America.
If we want to find ways to protect minority shareholders in the face of increasing ownership concentration, we can look to Switzerland as an example. Despite having lower shareholder protections, compared to the US, and a long history of high ownership concentration and controlling shareholders, the country maintains an advanced and dynamic economy. Since ownership concentration poses a challenge for protecting the interests of minority shareholders, one potential solution is to promote multiple shareholders. By having multiple significant shareholders, there is a greater chance of creating a buffer against opportunistic rent extraction and strengthening shareholder protection overall. In this post, we explore how multiple shareholders can help to address this critical issue and ensure that minority shareholders are not left behind.
When it comes to protecting minority shareholders in the face of concentrated ownership, one way to measure shareholder protection is by looking at the number of voluntarily implemented corporate governance mechanisms. Previous research has suggested that firms with one large shareholder tend to adopt fewer formal governance mechanisms. However, our hypothesis and subsequent testing indicate that having multiple large shareholders with diverging interests (such as family and private equity) leads to the adoption of more formal governance mechanisms. This, in turn, can lead to stronger shareholder protection overall. Therefore, we expect companies with more than one large shareholder to adopt more formal corporate governance mechanisms. We argue that the adoption of a larger number of formal mechanisms is not just a way to monitor other large shareholders, but it also serves to reconcile their diverging interests. This is because having multiple large shareholders with differing priorities can often create conflicts of interest that may harm the decision-making process and firm performance. By adopting more formal governance mechanisms, companies can provide a framework for resolving these conflicts and ensuring that all interests are represented fairly.
Our analysis reveals significant differences in shareholder protection based on the number of corporate governance mechanisms adopted. Our baseline results confirm previous research showing that higher ownership concentration leads to lower shareholder protection and a greater risk of rent extraction from small shareholders. However, our findings provide empirical support for our central theoretical reasoning that having more than one large shareholder in place is associated with better shareholder protection. Specifically, we find that having two or more large shareholders in place correlates with the adoption of a higher number of governance mechanisms.
However, not all shareholders are born equal. Our hypothesis is that the characteristics of shareholders play a critical role in promoting shareholder protection. We distinguish between two types of shareholders: beneficiary shareholders and fiduciary shareholders. Beneficiary shareholders, such as family firms and private equity investors, invest their own wealth in a firm and are directly involved in its management and governance. We categorize private equity investors as beneficiary shareholders due to their incentive structure, which aligns the fund managers with the interests of individual investors. These beneficiary shareholders are more likely to engage in governance by directly intervening in the firm’s decision-making processes. In contrast, fiduciary shareholders such as banks, corporations, government, and pension funds manage dispersed ownership on behalf of other people and are typically more passive in their investment approach. In Switzerland, fiduciary shareholders are known to be more buy-and-hold investors. This characteristic differs from many institutional investors in the US who are more vocal in the governance of the firms they invest in. When multiple active beneficiary shareholders are involved, conflicts of interest, also known as principal-principal conflicts, are more likely to arise than in situations with multiple passive fiduciary shareholders. As such, we expect the effect on shareholder protection to be weaker when there are several passive fiduciary shareholders involved.
Our analysis of the data reveals significant differences in shareholder protection based on the type of shareholders. We find that the results are more significant when the combination of shareholders includes two or more beneficiary shareholders (they both tend to use more active role -voice strategy- as an approach to governance). We also tested for the possibility of two or more large shareholders colluding to extract rents from smaller shareholders. However, we did not find evidence to support this argument. Alternatively, shareholders could exit or threaten to exit (sell their shares – exist strategy) if they feel their interests are not protected. Again, we do not find any significant influence of shareholders using an exit strategy in the additional adoption of governance mechanisms in the Swiss context. In sum, our results suggest that having multiple large, active shareholders with diverging interests can serve as a buffer against opportunistic rent extraction and promote stronger shareholder protection.
Our findings suggest that investors and policymakers should consider the benefits of having multiple large shareholders in place to enhance shareholder protection. This is particularly relevant in cases where both large shareholders use their power to challenge managerial decisions at odds with their interests. Their significant ownership allows governance mechanisms that prevent self-serving behavior. Better governance reconciles potential conflicting interests. Our results point towards a more holistic view of corporate governance mechanisms as tools for collaboration and alignment of interests, rather than just monitoring management. Additionally, our research highlights that stable ownership structures with multiple shareholders may be more effective than granting voting privileges to long-term shareholders. These insights could inform policy decisions and investment strategies aimed at improving corporate governance and protecting the interests of minority shareholders. One example of a step in this direction is the recent move by Blackrock in 2021 to enable some of their institutional investors to exercise their proxy voting rights in general assemblies. By encouraging greater engagement from institutional investors and other significant shareholders in improving the governance of firms, individual shareholders can also benefit. This approach recognizes the importance of collective action and cooperation among shareholders in promoting stronger shareholder protection and ensuring the long-term success of the company.
Raúl Barroso is an Assistant Professor of Financial Accounting at the IESEG School of Management.
Michael Burkert is the Chair of Managerial Accounting and Control at the University of Fribourg.
Antonio Dávila is a Full Professor at the University of Lausanne.
Daniel Oyon is a Full Professor at the University of Lausanne.
This post was adapted from their paper, “Shareholder Protection: The Role of Multiple Large Shareholders,” available on SSRN.