group affiliation, identity of managers, and the relation between managerial ownership and...

International Review of Financial Analysis 14 (2005) 533–558

Group affiliation, identity of managers,

and the relation between managerial

ownership and performance

Ming-Yuan Chen*

Department of Industrial Economics, Tamkang University, 151 Ying-Chuan Road, Tamshui, Taipei 25137, Taiwan

Available online 20 November 2004

Abstract

Two features in Taiwan’s companies complicate the ownership–performance relationship. First,

the firm’s management is usually controlled, either directly or indirectly via equity interlocks, by

the controlling family. The shareholding of managers is an access through which the controlling

owners can secure control and entrench their private benefits. Second, the management generally

consists of individual managers and representatives appointed to top managerial positions by

institutions that hold a substantial percentage of shares. The role of corporate managers played by

institutions is important in Taiwan’s companies. Echoing these two features, empirical results

suggest a low inflection point for the nonlinear relation between managerial ownership and

performance. Moreover, the impact of managerial ownership on performance varies between

different identities of managers and depends on whether the firm is group-affiliated or independent.

There is also evidence to show that the relation between individual and institutional managerial

ownership is complementary at low levels of ownership and becomes substitutive as ownership gets

higher.

D 2004 Elsevier Inc. All rights reserved.

JEL classification: G32; G34

Keywords: Managerial ownership; Performance; Group affiliation; Identity of managers

1057-5219/$ -

doi:10.1016/j.

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M.-Y. Chen / International Review of Financial Analysis 14 (2005) 533–558534

1. Introduction

The connection between managerial ownership and firm performance has been a focus

in the corporate finance literature. Jensen and Meckling (1976) argue that as managers’

equity ownership increases, their interests coincide more closely with those of outside

shareholders such that a positive relation between managerial ownership and firm

performance (value) is expected. Stulz (1988) develops a model of firm valuation to

explain how owning large shareholdings will make it easier for managers to be entrenched

and result in a negative relation between managerial ownership and performance.

However, Demsetz (1983) argues that the ownership structure of a corporation, thus the

level of managerial ownership, is an endogenous outcome of a profit-maximizing process

in which the influences of shareholders and of trading on the market for shares are

balanced to arrive at an equilibrium structure of the firm, so that there should be no

systematic relation between managerial ownership and performance.

Empirical evidence is also not conclusive. Demsetz and Lehn (1985) find no linear

relation between profit rate and ownership by large shareholders. They argue that this is

evidence to support that the ownership structure of the firm is optimally determined to

satisfy the principle of profit maximization. Other empirical articles, for example, Morck,

Shleifer and Vishny (1988), McConnell and Servaes (1990), and Short and Keasey (1999),

have used Tobin’s Q as a measure of corporate performance and shown that the relation

between performance and managerial ownership is nonlinear. While these studies do not

agree upon detailed results, they all report that in some ranges of managerial ownership,

Tobin’s Q is positively related to managerial ownership, but in others, a negative relation is

found. In general, they offer support for the positive binterest alignmentQ effect over

smaller ownership ranges, and for the negative bentrenchmentQ or bprivate benefit of

agencyQ effect over larger ownership ranges.

On the other hand, emphasizing the endogenicity of managerial ownership in

estimating its effect on firm performance, several studies apply simultaneous-equations

models to cross-sectional firm data. Agrawal and Knoeber (1996) use two-stage least

squares to estimate a seven-equation simultaneous model including Tobin’s Q, managerial

shareholdings, and five other control mechanism equations. Chung and Pruitt (1996) use

three-stage least squares to model relations between managerial ownership, compensation,

and Tobin’s Q. Chen and Steiner (2000) estimate a model with Tobin’s Q, managerial

ownership, and analyst coverage jointly determined within the system. Alternatively,

Himmelberg, Hubbard and Palia (1999) employ panel data to control the effect of

unobserved firm heterogeneity on firm performance via the bindividual effectsQ of the

fixed effects model, and use the specification of instrumental variables to mitigate the

potential endogenicity of managerial ownership.

This paper adds to the literature by examining the relation between managerial ownership

and firm performance in Taiwan. Two distinctive features in the management structure of

Taiwan’s corporations complicate this relationship and raise several questions that are rarely

considered in the studies based on US data. The first feature is that Taiwan is a country

whose economy is dominated by family-controlled conglomerates. The firm’s management

is usually controlled, either directly or indirectly via reciprocal shareholding, by the

controlling families. The shareholding of managers is thus an access through which the firm

M.-Y. Chen / International Review of Financial Analysis 14 (2005) 533–558 535

owners can secure control and entrench their private benefits. Managerial ownership in

Taiwan reflects the nature of an entrepreneur-run corporate sector more than a corporate

governance problem. The second feature is that there are two types of managers, one the

individual managers and the other the institutional managers, who are representatives

appointed to board or top managerial positions by institutions that hold a substantial

percentage of shares. While the US-based literature is interested in whether institutional

investors are able to exercise efficient monitoring on management, it is more important to

focus on the role of corporate managers played by institutions in Taiwan’s companies.

Several questions connecting the ownership–performance relationship with group

affiliation and managerial identity then arise. Does the distinctive ownership structure lead

to the impact of managerial ownership on firm performance remarkably different from the

findings of the existent literature? How does the effect of managerial ownership on

performance differ between group affiliates and non-group firms, and does it hold equally

for different identity of managers, namely, individual and institutional managers?

Meanwhile, do the impacts of individual and institutional managerial ownership on

performance vary with the status of group affiliation? Recognizing the identity of

managers also raises the possibility that the shareholdings of individual and institutional

managers correlate to each other. What is the correlation, substitution or complement,

between two types of managerial ownership, and is the correlation different between group

and non-group firms?

Hypotheses about these questions are developed and tested by simultaneous-equations

models with panel data. The panel data are balanced containing information about 229

listed companies of the Taiwan Stock Exchange in 1994 for the 1995�2000 period. After

controlling for unobserved firm heterogeneity and the time effect in the models, empirical

results suggest a very low inflection point for the impact of managerial ownership on

performance turning from positive to negative. This confirms the argument that a higher

level of managerial ownership in Taiwan’s companies generally implies the strengthening

of family control or the entrenchment of controlling owners’ private benefits. There is

evidence for the difference in the ownership–performance relationship between group

affiliates and non-group firms, reflecting the mechanism of internal capital market and the

lack of transparency in the locus of control embedded in the organization of business

groups. Empirical results also show that the relation between individual and institutional

managerial ownership depends on the levels of ownership. It is complementary at low

levels of ownership and becomes substitutive as ownership gets higher. The inflection

point for the nonlinear impact of ownership on performance is found to be lower for

individual managerial ownership than for institutional one for both group and non-group

firms. Furthermore, the organizational characteristics of business groups are also

responsible for the distinction between group and non-group firms in the effects of both

types of ownership on performance. In a word, empirical results lead us to conclude that

the identity of managers, in terms of individual managers and institutional representatives,

and its connection with the firm’s group affiliation are important to understand the relation

between managerial ownership and firm performance.

Section 2 describes the issues for managerial ownership in Taiwan and develops

testable hypotheses. Section 3 illustrates data and empirical specifications. Section 4

presents the empirical results, and Section 5 concludes the paper.


2. Issues and hypotheses

To understand the effect of managerial ownership on firm performance for Taiwan’s

companies, two features of the management structure are noteworthy. The first one is that

many companies are affiliated to family-controlled business groups, and the second

feature relates to the identity of managers in terms of individual and institutional

managers.

2.1. Family-controlled business groups

Like several East Asian countries, the economy of Taiwan is dominated by family-

controlled conglomerates. Many large corporations in Taiwan are members of business

groups, typically family-controlled. The corporations usually have controlling share-

holders, who are often founders, their descendants, or the relatives through marriage. Thus,

the organization of business groups with family members being the controlling owners is

one important feature of Taiwan’s corporate sector.

The useful function in corporate control served by the organization of business groups

has been discussed in the literature concerning Japanese keiretsu organizations (groups of

enterprises), for example, Aoki (1990), Flath (1993), Berglof and Perotti (1994), and Kim

and Limpaphayom (1998). Most group organizations are both diversified and vertically

integrated and most group members do much of buying and selling within their own

groups. There generally are extensive reciprocal shareholding within members of the

group, implicit mutual agreements not to sell share held reciprocally, and reciprocal trade

agreements. Within the group, a shareholder is likely to have a variety of relationships with

other firms via equity, credit, and trading contracts. These tight and long-term commercial

interactions that exist in the binternal capital marketQ formed by group members imply that

there are a number of methods through which shareholders can effectively monitor and

exert control over management. Group members can serve as mutual monitors because

extensive information sharing within the group enables them to observe and evaluate each

other’s financial conditions, prospects, policies and performances.

However, Khanna and Palepu (2000) describe the governance problems embedded in

the internal capital market of group firms. Group affiliates have a greater lack of

transparency in the locus of control over companies than unaffiliated firms, and hence are

more insulated from external monitors. In addition, group firms usually indulge in using

political connections to solicit privileges from the government and to leave financial

intermediaries no incentive to monitor. These problems are particularly severe if the

groups are controlled by families that attempt to protect their privacy with little

information about internal activities disclosed to the public. Furthermore, the presence of

controlling shareholders makes worse the problem of lacking transparency and outside

monitors in business groups. Shleifer and Vishny (1997) indicate that controlling

shareholders represent their own interests, which may not coincide with the interests of

other investors, employees and managers. They can redistribute or expropriate wealth from

others in the process of using their control right to pursue personal non-profit maximizing

objectives. The expropriation becomes much more important when other investors or

employees have their own firm-specific investments to make.


Recent studies, for example, La Porta, Lopez-de-Silanes and Shleifer (1999), Bebchuk

(1999), Claessens, Djankov and Lang (2000), and Bebchuk, Kraakman and Triantis

(2000), have emphasized that the separation between cash flow and control (voting) rights

through equity interlocks, such as stock pyramids and cross-ownership ties, is usually used

in conjunction with the controlling-shareholder structure. These schemes, which are called

controlling-minority structures by Bebchuk et al. (2000), enable controlling shareholders

(families) to exercise control over the firm assets with the least amount of capital. Bebchuk

(1999) argues that when private benefits of control are large, separating cash flow rights

from voting rights is a practical arrangement for corporate owners to take their companies

public or to raise additional outside capital. He indicates that private benefits of control are

relatively large when there are opportunities to engage in self-dealing transactions and in

the taking of corporate opportunities, and that the problem of self-dealing is particularly

serious in countries where the corporate law system is lax. Private control benefits of the

owners are also large when there are nonpecuniary benefits from controlling the firm,

which are likely to exist if the firm is controlled by the founder and his family members for

a long time or if the control provides the controller with glamour and prestige. Consistent

with these arguments, the controlling-minority structures are common in Taiwan because

of its relatively lax corporate laws and large nonpecuniary benefits from controlling.1

After the studies of La Porta et al. (1999) and Claessens et al. (2000) in calculating the

ultimate control right of the firm, many researchers accept that in analyzing the causes and

consequences of ownership for the countries where the controlling-minority structures are

common, the ultimate ownership has to be investigated. However, to make a comparison

with the existent US-based literature, we can look at this notion from a different angle, that

is, what are the implications or influences of the controlling-minority structures on the

impact of managerial ownership (immediate ownership) on firm performance. Based on

the above discussions, two testable implications about the impact of managerial ownership

on firm performance can be developed.2

1 In their study of East Asia countries by identifying the company’s ultimate control, Claessens et al. (2000)

find that for Taiwan’s non-widely held companies, 79.8% of sample companies have top managers being the

relatives of the controlling shareholder’s family, 43.3% of them are controlled by a single shareholder, and 49%

and 8.6% of them are controlled through pyramid structures and cross-holdings, respectively.2 Another reason to consider immediate ownership rather than ultimate control is that the relevant information

required to compute ultimate ownership is not clearly and uniformly reported by Taiwan’s companies. A lot of

inconsistencies occur while we check the firm’s equity interlocks and ownership data in detail. As a result, many

calculations are left to researchers’ own discretion, which severely affects the accuracy of ultimate ownership and

biases the empirical results. Meanwhile, one purpose of this study is to examine the different effects of individual

and institutional managerial ownership on performance in firms with different status of group affiliation. This aim

cannot be reached if the ownership is measured in ultimate control. For example, even though all shareholdings of

individual and institutional managers directly or indirectly belong to the same controlling owners (in this case, the

measurement of ultimate ownership will pool individual and institutional managerial ownership in the same

ultimate owner), the changes in the holdings of individual and institutional managers will convey different

information to the market and hence have different performance impacts. It is not appropriate to argue that

individual and institutional managers have homogeneous behavior and ignore the interrelation between both

parties just because they have the same controlling owners. To arrange an efficient managerial ownership

structure, the owners of firms, even in the controlling-minority structures, have to understand the motivations and

effects of ownership held by different identities of managers.


First, since the firm’s management tends to be controlled, either directly or indirectly

via the arrangement of equity interlocks, by the controlling families, an increase of

managerial ownership is likely to be perceived in the market as reinforcement of family

control over the firm or exacerbation of the lack of transparency. It might also reflect

the intention of controlling families to increase expropriation of minority shareholders

and other stakeholders or to reform the linkage of managerial equity for the

entrenchment of private control benefits. While an increase of managerial ownership

is usually argued to improve firm performance because of the convergence-of-interest

effect, the negative impact resulting from the potential of expropriation and entrench-

ment implied in the controlling-shareholder structure is expected to dominate the impact

of managerial ownership on firm performance, and become more significant at higher

levels of managerial ownership. This feature expressed in the nonlinear ownership–

performance relationship suggested by the prior literature will be a very low inflection

point for the impact of ownership changing from positive to negative. The positive

impact of ownership can be shown only in the very low levels of managerial

ownership.

The second implication is that the impact of managerial ownership on firm performance

differs between group and non-group firms. The difference may come from two sources.

First, the internal capital market for group members, which serves the function of mutual

monitoring and information sharing, can alleviate or smooth the impact of changes in

managerial ownership on firm performance. This mechanism is expected to work no

matter how managerial ownership affects performance, either positively or negatively. In

other words, firm performance will be less sensitive to the changes of managerial

ownership for group firms. Second, because the lack of transparency is more severe in

group firms and because equity interlocks for private control benefits can be easily

developed among group members, the negative entrenchment effect associated with an

increase of managerial ownership is more likely to exceed its positive interest-alignment

effect for group firms than for non-group firms. Evaluating these two sources, one can

argue that since the negative entrenchment effect tends to be pronounced at higher levels

of managerial ownership, for the difference between group and non-group firms in the

ownership–performance relationship, the smoothing effect of the internal capital market is

likely to be seen at low levels of ownership and the entrenchment effect will dominate the

difference as ownership gets higher.

2.2. The identity of managers

Another notable feature in the management of Taiwan’s companies is that it includes

not only the individual managers but the institutional managers, who are representatives

appointed to board or key managerial positions by institutional investors that hold a

substantial portion of corporate shares. Hence, there are two types of managerial

ownership. One is the ownership of individual managers, and the other is the ownership of

institutional managers, which represents the shares held by institutions. Through the

managerial positions, institutional investors have direct access to corporate resources and

are able to secure their interests on the firm. It is usually argued in the literature that

institutional investors, particularly the financial institutions, play the role of monitoring on


management. However, financial institutions in Taiwan do not have substantial monitoring

actions in practice because they are usually affiliated to the controllers of the firms or have

strategic interests to cooperate. Therefore, since institutions directly appoint representa-

tives to the management, while the main issue addressed in prior studies about the role of

institutions is whether they are willing to and able to exercise efficient monitoring on

management, it would be more meaningful to focus on the role of managers, instead of

monitors, played by institutions in Taiwan’s companies.

Once we emphasize the role of managers for institutions and distinguish two types of

managerial ownership, the differences between shareholdings of individual managers and

institutional managers in their motivations and effects are an issue that cannot be ignored.

In the limited literature, one can refer to an earlier study on the majority shareholders by

Holderness and Sheehan (1988). They point out the distinction between individual and

corporate large-block shareholders, and find that differences in the investment policies, the

frequency of corporate-control transactions, accounting returns, and Tobin’s Q do emerge

between firms with individual and corporate majority shareholders. They suggest that it is

important to know whether the results of the studies by Demsetz and Lehn (1985) and

Morck et al. (1988) hold equally for individual and corporate majority shareholders. In a

recent article studying the constraints on majority shareholders, Holderness and Sheehan

(2000) also indicate that when individuals rather than corporations are majority

shareholders, the firms have fewer organizational constraints on management, such as a

lower ratio of outside to inside directors or a lower debt to asset ratio. Since almost all

majority shareholders are directors and top officers of the firms, studies by Holderness and

Sheehan imply the identity of managers in terms of individuals and corporations

(institutions) to be an important element in examining the relation between managerial

ownership and performance.

The distinction between individual and institutional managers brings into question the

relation between ownership of both parties. Because the same nature of ownership is held

by two types of managers with different motivations in making policies and because the

size of ownership can reasonably represent the degree of dominance over the manage-

ment, from the standpoint of obtaining control over the management and corporate

resources, the relation between ownership of individual and institutional managers within

the management can be complementary or substitutive depending on the levels of their

ownership. The strategic alignment to cooperate is likely to exist when the percentage of

ownership is small and the capability of competing for corporate resources is low,

suggesting a complementary or a positive relation between both types of ownership. On

the contrary, competition will be seen at higher levels of ownership as large percentages of

ownership represent greater abilities to compete, implying a substitutive or a negative

relation between both types of managerial ownership. Moreover, the degree of comple-

ment or substitution differs between group and non-group firms. The relatively more

flexibility in adjusting ownership through the arrangement of shareholding among group

members suggests that group firms can exhibit a larger degree of complement or

substitution than non-group firms if there is cooperation or competition between two types

of managers.

The impacts of both individual and institutional managerial ownership on firm

performance are expected to follow the pattern of ownership–performance relationship


described earlier. That is, the negative expropriation or entrenchment effect implied in

the controlling-shareholder structure will dominate their impacts on firm performance

and show low inflection points in their nonlinear relation with performance. Two

sources of differences stated in the previous section between group and non-group firms

in the ownership–performance relationship, which are the smoothing effect at low levels

of ownership and the stronger entrenchment effect at high levels of ownership for group

firms, also work for both individual and institutional managerial ownership.

Furthermore, there are differences in the impacts on firm performance between

individual and institutional managerial ownership. Individual managers are often

controlling shareholders or large shareholders, who are likely to have direct and close

relationship with the controlling shareholders. In the controlling-shareholder structure,

although equity interlocks through institutional managers can be a means for the

controlling owners to entrench, an increase in the ownership of individual managers will

directly reflect the owner’s or large shareholders’ intention to expropriate or to entrench.

As a result, one can expect individual managerial ownership to have a stronger negative

impact on firm performance or a lower inflection point in the nonlinear ownership–

performance relationship than institutional managerial ownership for both group and

non-group firms.

The calculation for the effects of individual and institutional managerial ownership on

firm performance will become more complicated if potential substitution or complement

between both types of ownership has been considered. For example, the effect of a change

in individual ownership can possibly be carried to firm performance through two channels:

one is its direct effect on performance, and the other is the indirect effect through

institutional ownership as a result of the substitution or complement effect. Suppose that

both individual and institutional managerial holdings adversely affect performance and

that the negative effect is stronger for individual ones, the substitution effect will imply the

possibility that an increase in institutional holdings gives rise to higher performance even

though its direct effect is to depress performance. The reason is that it can substitute for the

shares of individual managers, of which the negative impact is stronger, to create a positive

indirect effect that is large enough to offset the direct one. Computing the direct, indirect,

and hence total effects, and understanding the interrelation between the impacts of

individual and institutional managerial ownership on performance seem to be interesting

once the identity of managers is taken into account.

3. Data and model specification

To address the questions I have posed, I employ simultaneous-equations models to

examine a panel data set of Taiwan’s listed companies. The sample is restricted to non-

financial firms that were listed on the Taiwan Stock Exchange (TSE) in 1994, had at least

one-year trading on the market (i.e., newly listed companies during 1994 are excluded),

and reported complete ownership data over the period 1995�2000 in the TEJ Profile

Databank maintained by Taiwan Economic Journal. According to the records of

Securities and Futures Commission of Taiwan, there were 313 companies listed on the

TSE by the end of 1994. After excluding 29 financial companies, 28 newly listed


companies in 1994, and 27 companies that did not report complete ownership data in all

subsequent years, the data panel is balanced and has 1374 observations for 229 firms.3

The purpose of applying simultaneous-equations models to panel data is to deal with

the endogenicity of managerial ownership in studying its effect on firm performance. The

endogenicity of managerial ownership in regressing firm performance on managerial

ownership can be considered in two folds. First, performance (the regressand) is at least as

likely to affect ownership (the regressor) as ownership is to affect performance. That is, the

causality between firm performance and managerial ownership can go either way.

Previous studies using simultaneous-equations models have accepted the argument that the

ownership structure is endogenous and determined, among other observed factors, by firm

performance. Demsetz and Villalonga (2001) point out that the insider information creates

the incentive for managers to change their holdings according to their expectation of future

firm performance, and that the performance-based compensation in the form of stock

options also raises the possibility that firm performance is likely to affect managerial

ownership.

Secondly, it is possible that the relation between performance and managerial

ownership is neither a correlation running from ownership to performance nor a reverse

correlation in which performance affects ownership, but rather a spurious relation

attributed to unobserved heterogeneity among firms. Suppose there is an unobserved firm

characteristic that is positively related to both performance and managerial ownership. If

the variables for this unobserved characteristic are omitted from the specification, a

regression of firm performance on managerial ownership will spuriously indicate a

positive relation because managerial ownership is a positive proxy for this firm

characteristic. Using panel data and assuming unobserved firm heterogeneity to be the

bfixed individual effectQ is a way to mitigate the endogenicity caused by the spurious

relation. This point is emphasized in the study by Himmelberg et al. (1999).

There are two simultaneous-equations models in this paper. The first one is a two-

equation system, in which total managerial ownership (MO) and firm performance

(Tobin’s Q) are endogenous. The structural equations are as follows.

MOit ¼ l1 þ a1i þ d1t þ b11Qit þ b12ðQit � GPitÞ þ b13Ln ASSETð Þitþ b14Ln AGEð Þit þ b15RETSDit þ b16RETSD2it þ b17DEBTAit

þ b18GPit þ e1it; ð1Þ

Qit ¼ l2 þ a2i þ d2t þ b21MOit þ b22MO2it þ b23ðMOit � GPitÞþ b24ðMO2it � GPitÞ þ b25Ln ASSETð Þit þ b26DEBTAit þ b27RDA

þ b28ROA þ b29GPit þ e2it; ð2Þ

where i and t represent individual firm and time, respectively. Tobin’s Q appears as an

explanatory variable in the MO equation because of the potential causality running from

3 The sample selection prevents entry and exit during 1995–2000. New firms and firms that go busted are likely

to have abnormal transactions in the corporate shareholdings. To avoid econometric biases, I do not add them to

the firms with normal operation.


performance to ownership. The inclusion of MO and its squared value (MO2) in the Q

equation is to test a curvilinear relation between managerial ownership and performance.

MO is measured as the percentage of the firm’s common equity held by all managers

(directors and top executives). Tobin’s Q is measured by proxy Q, defined as the sum of

the market value of common equity, the market value of preferred stock and the book

value of total debt, divided by the book value of total assets.

The exogenous variables in the system include firm size, firm age, business risk, the

value of debt, research and development, profitability, and the status of group affiliation.

Firm size is measured as the logarithm of the firm’s total assets (Ln(ASSET)). The larger is

the firm size, the larger is the amount that has to be invested in the firm for a given fraction

of equity. Financial constraints prevent managers from owning a high percentage of equity.

Moreover, to attain a given degree of control or to induce a given interest-converging

incentive of managers, a smaller share of the firm is required as firm size increases. Hence,

previous studies usually argue managerial ownership to decrease with firm size. Firm age

is calculated as the logarithm of the number of years since the firm’s establishment

(Ln(AGE)). The life-cycle theory suggests that younger firms are more likely to have

concentrated ownership, while older firms are frequently widely held.

The annual business risk of the firm is estimated as the standard deviation of the firm’s

weekly stock market rates of return (RETSD). The squared value of the business risk

(RETSD2) is also included. Demsetz and Lehn (1985) argue that greater payoff potential

in maintaining tighter control in less stable environments will call for greater ownership

concentration. Because managerial behavior is more difficult to monitor and more crucial

in profitability when the firm’s environment is less predictable, higher risks will increase

the value of incentive contracts with large managerial ownership. However, at higher

values of managerial ownership, the increase in concentration of ownership associated

with a given increase in instability diminishes.

The value of debt is measured as total debt divided by total assets (DEBTA). According

to Jensen’s (1986) bcontrol hypothesisQ for debt, debt reduces the free cash flow available

for spending at the discretion of managers by bonding managers’ promise to make the

interest and principal payments. Therefore, in the ownership equation a larger value of

debt will be associated with lower managerial ownership because it reduces the importance

of managerial ownership being a convergence-of-interest mechanism. In addition, if

creditors do provide monitoring of management, debt issue can discourage managers to

entrench themselves through large shareholdings. DEBTA is also included in the

performance equation to examine whether the benefits of debt in motivating managerial

and organizational efficiency can exceed the agency costs of debt, suggested by Jensen

and Meckling (1976), to improve firm performance.

Research and development is measured as research and development expenditures

divided by total sales (RDA). Profitability is defined as earnings before interest and taxes

divided by total assets (ROA). Both RDA and ROA are expected to positively affect firm

valuation. A dummy variable (GP) is proxy for the status of group affiliation. GP is equal

to one if a firm is affiliated to business groups. The terms interacting Q and MO with GP,

that is, Q�GP, MO�GP, and MO2�GP, are added to the regressions. The inclusion of GP

and related interaction variables, which allows us to examine the implications discussed in

section two, is a major feature of the model.


Alternative to the curvilinear specification of MO in the Q equation, the piecewise

linear approach suggested by Morck et al. (1988) is also employed. That is,

Qit ¼ l2 þ a2i þ d2t þ b21MAit þ b22MBit þ b23MCit þ b24ðMAit � GPitÞþ b25ðMBit � GPitÞ þ b26ðMCit � GPitÞ þ b27Ln ASSETð Þit þ b28DEBTAit

þ b29RDA þ b210ROA þ b211GPit þ e2it; ð3Þ

where MA, MB, and MC represent three different ranges of MO with two turning points,

and MA�GP, MB�GP, and MC�GP are their interactions with GP. In the case that three

turning points are used, MD and MD�GP are added to the regression.

The second model is a three-equation system, in which ownership of individual

managers (INDMO), ownership of institutional managers (INSTMO), and firm perform-

ance are endogenous. INDMO is measured as the percentage of the common equity held

by individual managers. INSTMO is the percentage of the common equity held by

managers who are institutional representatives, that is, the shareholdings of institutions

that have representatives in the managerial positions. Since piecewise linear regressions

reveal more specific information than curvilinear ones, to simplify the discussions, the

results of curvilinear regressions are not reported. The structural equations for the

piecewise linear model are as follows.

INSTMOit ¼ l1 þ a1i þ d1t þ b11Qit þ b12ðQit � GPitÞ þ b13INDMAit

þ b14INDMBit þ b15INDMCit þ b16ðINDMAit � GPitÞþ b17ðINDMBit � GPitÞ þ b18ðINDMCit � GPitÞ þ b19Ln ASSETð Þitþ b110Ln AGEð Þit þ b111RETSDit þ b112RETSD2it þ b113DEBTAit


INDMOit ¼ l2 þ a2i þ d2t þ b21Qit þ b22ðQit � GPitÞ þ b23INSTMAit

þ b24INSTMBit þ b25INSTMCit þ b26ðINSTMAit � GPitÞþ b27ðINSTMBit � GPitÞ þ b28ðINSTMCit � GPitÞ þ b29Ln ASSETð Þitþ b210Ln AGEð Þit þ b211RETSDit þ b212RETSD2it þ b213DEBTAit


Qit ¼ l3 þ a3i þ d3t þ b31INDMAit þ b32INDMBit þ b33INDMCit

þ b34ðINDMAit � GPitÞ þ b35ðINDMBit � GPitÞ þ b36ðINDMCit � GPitÞþ b37INSTMAit þ b38INSTMBit þ b39INSTMCit þ b310ðINSTMAit � GPitÞþ b311ðINSTMBit � GPitÞ þ b312ðINSTMCit � GPitÞ þ b313Ln ASSETð Þitþ b314DEBTAit þ b315RDA þ b316ROA þ b317GPit þ e3it: ð6Þ

In the above model, INDMA, INDMB, INDMC, and INSTMA, INSTMB, INSTMC

represent three different ranges of INDMO and INSTMO, respectively. To consider the

relation between ownership of individual and institutional managers, INDMA, INDMB,

and INDMC are included as explanatory variables in the INSTMO equation, and


INSTMA, INSTMB, and INSTMC are explanatory variables in the INDMO equation. The

interaction terms of these variables with GP are added to the regressions. They are

purposed to examine the difference between group and non-group firms in the relation

between ownership of individual and institutional managers, and in the roles played by

individual and institutional managers in affecting performance. Exogenous variables of the

system are the same as those of the first model.

Both models are two-way fixed effect specifications, in which the individual effects for

each firm (dummy variables ai) and the time effects for each period (dummy variables dt)

are taken into account. One of the time effects must be dropped to avoid perfect

colinearity. Since each of the individual effects is an individual-specific intercept but the

time effects are comparisons to a base period, as suggested by Greene (2000), an overall

constant (l) must be included to formulate a symmetric form of the model. All equations

in both models are over-identified so that the two-stage least squares (2SLS) methodology

can be used. It is important to note that both models have the terms interacting GP with

endogenous variables, such as MO, MO2, INDMO, INSTMO, and Q. In this case, the

instrumental variables for estimating the reduced form equations in the 2SLS method

include not only all exogenous variables but also the products when the exogenous

variables are multiplied by GP.

Information about the ownership and identity of managers in calculating MO, INDMO,

and INSTMO is available from the TEJ Profile Databank, which by collecting data from

companies’ financial reports and other relevant sources provides the managers’ names,

their identity (individual or institutional representatives), their percentage of share-

holdings, and the names and types of institutions that appoint managerial representatives.

Many institutions place more than one representative in the management. For this case,

multiple representatives report the identical percentage of shareholdings (the ownership of

institutions they represent) in the TEJ Profile Databank . Since these multiple

representatives stand for the interests of the same institution, they should be identified

as the same institutional manager. The figures of ownership are carefully checked to avoid

double counting.

Data required to compute the values of Tobin’s Q, Ln(ASSET), RETSD, DEBTA,

RDA, ROA are all retrieved from the TEJ Finance Databank. The year of the firm’s

establishment for calculating Ln(AGE) is obtained from the Taiwan Securities and Futures

Institute. Information about a firm’s affiliation with business groups (the dummy GP) is

available from Business Groups in Taiwan published by the China Credit Information

Service, which provides the most reliable data for business groups of Taiwan. The status of

a firm’s group affiliation according to the criteria of China Credit Information Service may

change during 1995�2000. Of 1374 observations, 741 are classified as group affiliates.

4. Empirical results

4.1. Summary statistics

Table 1 reports summary statistics. Panel A contains descriptive statistics for the

variables used in the models, and panel B shows the mean values of managerial ownership

Table 1

Summary statistics

Panel A. Descriptive statistics for variables used in the models

All firms (N=1374) Group firms (N=741) Non-group firms (N=633)

Mean Std. Dev. Min. Max. Mean Std. Dev. Min. Max. Mean Std. Dev. Min. Max.

Q 1.312 0.817 0.037 6.491 1.195*** 0.724 0.066 4.967 1.450 0.896 0.037 6.491

MO(%) 23.099 13.608 0.750 82.415 23.740* 14.475 4.775 81.870 22.349 12.488 0.750 82.415

INDMO(%) 10.156 11.145 0.000 70.555 8.349*** 10.214 0.000 54.725 12.271 11.806 0.000 70.555

INSTMO(%) 12.944 14.894 0.000 82.405 15.391*** 16.221 0.000 81.860 10.078 12.593 0.000 82.405

Ln(ASSET) 22.846 1.052 20.281 26.155 23.331*** 1.007 20.701 26.155 22.280 0.788 20.281 25.820

Ln(AGE) 3.323 0.349 1.946 3.989 3.365*** 0.347 2.079 3.989 3.273 0.346 1.946 3.932

RETSD(%) 6.134 2.153 0.466 20.079 5.915*** 1.983 2.216 13.415 6.391 2.313 0.466 20.079

DEBTA 0.398 0.145 0.061 0.866 0.413*** 0.136 0.065 0.854 0.380 0.154 0.061 0.866

RDA 0.006 0.012 0.000 0.091 0.005 0.011 0.000 0.061 0.006 0.013 0.000 0.091

ROA 0.045 0.083 �0.983 0.382 0.053*** 0.064 �0.216 0.382 0.036 0.100 �0.983 0.326

Panel B. Mean values of managerial ownership and Tobin’s Q, 1995–2000

1995 1996 1997 1998 1999 2000

All firms

MO(%) 26.12 24.67 23.52 22.31 21.34 20.63

INDMO(%) 12.64 11.45 10.47 9.55 8.69 8.13

INSTMO(%) 13.48 13.22 13.05 12.76 12.65 12.49

Q 1.648 1.473 1.546 1.319 1.056 0.832

Group firms

MO(%) 25.41 26.30 25.20 23.06 22.11 21.47

INDMO(%) 9.35 9.15 8.59 8.35 7.73 7.35

INSTMO(%) 16.06 17.15 16.61 14.71 14.38 14.12

Q 1.525 1.354 1.378 1.230 1.035 0.787

Non-group firms

MO(%) 26.71 23.09 21.89 21.20 20.20 19.37

INDMO(%) 15.37 13.69 12.30 11.36 10.13 9.30

INSTMO(%) 11.34 9.40 9.59 9.84 10.07 10.07

Q 1.750 1.589 1.709 1.452 1.087 0.899

* and *** denote that the mean values are significantly different between group and non-group firms at the 0.10, and 0.01 significance level, respectively. Mean differences are tested using t-test

with unequal variances.

M.-Y

.Chen

/Intern

atio

nalReview

ofFinancia

lAnalysis

14(2005)533–558

545


and Q over the period 1995–2000. The mean values in panel A suggest that, relative to

non-group firms, group affiliates have lower Q, higher ownership held by total managers

(MO), lower ownership of individual managers (INDMO), and higher ownership of

managers appointed by institutions (INSTMO). All of these differences are significant at

conventional levels. The mean value of INSTMO is larger than that of INDMO (almost

double) for group firms and is smaller for non-group firms, reflecting the prevalence of

appointing institutional managers in business groups. Group firms are also larger and

older, have lower business risks, sell more debts, and have higher profitability. The mean

value of research and development expenditures of group firms, however, is not

significantly different from that of non-group firms.

Panel B indicates that from 1995 to 2000, the average Q of all sample firms drops by

0.816 and the mean values of MO and INDMO decrease by 5.49% and 4.51%,

respectively. The decline in the mean value of INSTMO is relatively small. The

simultaneous declines of average Q and managerial ownership over the period 1995–2000

imply that the time effect will strengthen or cause spurious positive relation between

managerial ownership and Q in examining the pooled data, even though the relation does

not exist or the true correlation is negative. Without controlling the time effect, the

correlation between managerial ownership and performance is upward biased. Meanwhile,

the stable level of average INSTMO over periods suggests that the decline of MO is

largely attributed to the change of INDMO.

Panel B also reveals that although average Q’s for both group and non-group firms drop

by around 48% from 1995 to 2000, the reduction in MO for group firms (3.94%) is only a

half of that for non-group firms (7.34%). Also, the declines in the mean values of INDMO

and INSTMO are similar for group firms (about 2%), but are different for non-group firms

(6.07% vs. 1.27%). These show the differences between group and non-group firms in the

correlation between managerial ownership and firm performance and in the bias of the

ownership–performance relationship caused by the time effect.

The correlations implied in panel B of Table 1, however, do not suggest any causality.

One cannot identify whether the movements of MO, INDMO, INSTMO, and Q in the

same direction during the sample period are the causality running from managerial

ownership to performance or the reverse. A formal analysis of simultaneous-equations

models controlling for both firm and time effects is necessary to answer this question.

4.2. The relation between ownership of all managers and performance

Empirical results of the first simultaneous-equations model are presented in Table 2.

The MO equation (1) and the Q equation in panel A reports the test of a curvilinear

relation between performance and total managerial ownership. In addition, to further

distinguish the difference between group and non-group firms in the relation between MO

and its determinants, I also estimate the system where the terms interacting Ln(ASSET),

Ln(AGE), RETSD, RETSD2, DEBTAwith GP are included to the MO equation (the MO

equation (2) in panel A). Because this inclusion does not add other exogenous variables to

the system, regression results of the Q equation do not change. Panel B is the regression

results where managerial ownership is specified in a piecewise linear form in the Q

equation. Several possible linear segments are tested and two of them are reported in the

Table 2

Regression results of Model 1—simultaneous-equations model of total managerial ownership and firm

performance

Panel A: Curvilinear simultaneous equations

Variable MO equation (1) MO equation (2) Q equation

Constant 48.522 (0.016) 29.264 (0.161) �4.139 (0.004)

Q �2.324 (0.003) �1.680 (0.058)

Q�GP 0.857 (0.199) 0.779 (0.417)

MO �0.037 (0.080)

MO2 �0.45�10�4 (0.892)

MO�GP 0.032 (0.103)

MO2�GP �0.47�10�3 (0.121)

Ln(ASSET) 1.107 (0.124) 1.979 (0.009) 0.308 (0.000)

Ln(AGE) �14.396 (0.003) �13.877 (0.006)

RETSD 0.664 (0.032) 0.098 (0.788)

RETSD2 �0.054 (0.004) �0.023 (0.295)

DEBTA �3.324 (0.204) �4.539 (0.143) �2.000 (0.000)

RDA 6.109 (0.255)

ROA 0.863 (0.000)

GP �1.555 (0.141) 50.755 (0.000) �0.339 (0.186)

Ln(ASSET)�GP �2.612 (0.000)

Ln(AGE)�GP �0.059 (0.968)

RETSD�GP 1.683 (0.005)

RETSD2�GP �0.108 (0.008)

DEBTA�GP 4.917 (0.217)

Adj. R2 0.896 0.898 0.743

F stat. 50.280 50.280 17.360

Effects of variables having interaction with GP in the regression when GP=1a

Q �1.467 (0.089) �0.901 (0.330)

MO �0.005 (0.835)

MO2 �0.52�10�3 (0.232)

Ln(ASSET) �0.633 (0.432)

Ln(AGE) �13.936 (0.014)

RETSD 1.781 (0.001)

RETSD2 �0.131 (0.001)

DEBTA 0.378 (0.913)

Panel B: Piecewise linear simultaneous equations

Variable MO equation Q equation (1),

turning points:

3%, 7%

Q equation (2),

turning points:

3%, 7%, 25%

Constant 77.327 (0.000) �4.651 (0.002) �5.104 (0.001)

Q �2.241 (0.104)

Q�GP 1.668 (0.038)

MA 0.396 (0.039) 0.408 (0.033)

MB �0.286 (0.000) �0.294 (0.000)

MC �0.027 (0.021) �0.011 (0.492)

MD �0.034 (0.006)

MA�GP �0.280 (0.752) �0.294 (0.740)

(continued on next page)


Panel B: Piecewise linear simultaneous equations

Variable MO equation Q equation (1),

turning points:

3%, 7%

Q equation (2),

turning points:

3%, 7%, 25%

MB�GP 0.147 (0.066) 0.159 (0.050)

MC�GP �0.001 (0.746) �0.009 (0.346)

MD�GP �0.001 (0.872)

Ln(ASSET) 0.757 (0.308) 0.310 (0.000) 0.322 (0.000)

Ln(AGE) �20.658 (0.000)

RETSD 0.594 (0.054)

RETSD2 �0.052 (0.007)

DEBTA �2.636 (0.468) �2.101 (0.000) �2.079 (0.000)

RDA 3.149 (0.556) 3.563 (0.505)

ROA 0.923 (0.000) 0.918 (0.000)

GP �2.675 (0.025) 0.325 (0.900) 0.404 (0.877)

Adj. R2 0.896 0.744 0.744

F stat. 50.080 17.340 17.220


Q �0.573 (0.639)

MA 0.116 (0.893) 0.114 (0.896)

MB �0.139 (0.004) �0.135 (0.006)

MC �0.028 (0.018) �0.020 (0.172)

MD �0.035 (0.013)

p-values are in parentheses. The estimated results of a i and d t are not reported in the table.a They are calculated by adding up the coefficients of themselves and of their interaction terms with GP.

Table 2 (continued)


table: one is two turning points (3% and 7%) and the other is three turning points (3%, 7%,

and 25%).4 For each explanatory variable having the interaction term with GP included in

the regressions, its coefficient represents the effect for non-group firms. For the

convenience of discussions, I also report its effect for group firms (when GP=1) in the

table by adding up the coefficient of itself and of its interaction term with GP.

From panels A and B of Table 2, the equation purporting to explain variations in MO

uniformly shows that the effect of Q on MO is negative and is significant for non-group

firms. Contrary to the usual expectation that high Q leads managers to hold more shares,

there is a suggestion that managers choose to hold fewer shares when firms have good

performance, probably selling shares during good times in the expectation that today’s

good performance will be followed by poorer performance. The negative impact of

performance on managerial holdings is also found by Demsetz and Villalonga (2001).

Different from the result of prior research, managerial ownership is found to increase

with firm size (Ln(ASSET)) with weak significance in the MO equation (1) of panel A.

Results of the MO equation (2) further suggest that this finding is derived from the

4 One may note that the first turning point (3%) is low in these two specifications. Other unreported regressions

with first turning point higher than 3% cannot find a positive ownership–performance relationship in the first

segment of managerial ownership for both group and non-group firms. This result echoes the feature of low

inflection point described in Section 2.


significantly positive size-ownership relationship in non-group firms. Ln(ASSET) is

negatively related to MO for group firms as expected, although not significant. There is

one possible explanation for this difference. Compared with group firms with financial

support of the entire group, it would be more difficult for non-group firms to have

enough internal funds for extending the business. While non-group firms’ owners may

raise outside capital through equity financing for the development of the business, they

also hope not to give up the firm’s control rights. Hence, according to the argument of

Bebchuk (1999), the expansion of non-group firm size is more likely to be accompanied

with pyramid or cross-ownership arrangements. For example, the firm owner can

establish a holding company to raise equity capital and hold a controlling stake in that

company, which in turn holds a controlling stake of the operating company. As firm size

grows, managerial ownership increases because of managerial equity interlocks.

Consistent with the life-cycle theory that dispersion of ownership is just a matter of

time, a significantly negative coefficient of Ln(AGE) means old firms to have less

concentrated managerial ownership. As hypothesized, RETSD has a positive and

decreasing (negative coefficient for RETSD2) effect on the fraction of shares held by

managers. This nonlinear relation between risk and managerial ownership is particularly

important for group firms, as a reflection of the flexibility of group firms to adjust

managerial ownership in the face of high business risks. There is some support for the

notion that debt issue (DEBTA) replaces MO to be an interest-alignment mechanism or

prevents managers from entrenching themselves through large shareholdings. This effect

of debt is stronger for non-group firms probably because managerial ownership in group

firms means more than in non-group firms to serve the strategy of reciprocal shareholding

instead of the agency-cost-reducing mechanism.

From the Q equation of panel A, the impact of managerial ownership on Tobin’s Q

appears to be initially downward sloping without inflection points for both group and non-

group firms, in contradiction to the findings of the existent literature based on US data.

Coefficients for the interaction terms of MO and MO2 with GP suggest that the difference

between group and non-group firms in the effect of MO does exist at about 10%

significance level. Compared with non-group firms, the negative impact of MO on

performance for group firms is weaker at low levels of MO, but gets larger more quickly as

MO increases. The strictly negative impact of MO shown in the curvilinear relation may

not persuasive because it implies that the best performance will exist when there is no

managerial ownership. The piecewise regressions in panel B are purposed to find out the

inflection point in the ownership–performance relationship. From the results of the Q

equations (1) and (2), for both group and non-group firms the impacts of managerial

ownership on performance are found to be positive at the 0�3% range (insignificant in the

case of group firms) and turn to negative in the range higher than 3%, particularly in the

range of 3�7%. The low inflection point evident in these results supports the argument

stated earlier that compared with the findings of existent US-based studies, for firms with

the controlling-shareholder structure, the incentive alignment will be overwhelmed by the

expropriation or entrenchment effect at relatively lower levels of managerial ownership.

Furthermore, comparing the effects of ownership on performance in different segments

for group and non-group firms, one can also find that both the positive impact in the

0�3% range and the negative impact in the 3�7% range are stronger for non-group firms,


for example, 0.396 vs. 0.116 and �0.286 vs. �0.139 in the Q equation (1). However, the

negative impact in the range higher than 7% is weaker for non-group firms, particularly in

the 7%�25% range, as shown in the results of the Q equation (2). These findings are

consistent with the characteristics of the group firms argued in Section 2. For group firms,

the smoothing effect of internal capital market will make their performance less sensitive

to the change of managerial ownership at low levels of ownership, however, the negative

entrenchment effect tends to dominate as managerial ownership increases.

Ln(ASSET) is a significantly positive determinant of Tobin’s Q. It reflects a common

view in Taiwan. Large firms are more likely to have higher market-related performance

because investors usually believe that the operation of large firms is supported by

abundant resources and superior relation with financial institutions and government

agencies. DEBT is negatively related to Q. It seems to suggest that the agency costs of debt

suggested by Jensen and Meckling (1976) exceed the control benefits of debt and

dominate the effect of debt issue on firm performance. Consistent with prior findings for

the Tobin’s Q, profitability (ROA) carries positive coefficients and is highly significant.

The research and development expenditures (RDA) are also positively related to firm

valuation, although not statistically significant. Finally, it is not appropriate to conclude the

differences in the causes and consequences of managerial ownership between group and

non-group firms just looking at the coefficient of GP. Regression results suggest that the

effect of group affiliation on MO depends on its interaction with other determinants of

managerial ownership, and its impact on Q also interacts with the level of managerial

ownership.

4.3. The relation between ownership of individual managers, ownership of institutional

managers, and performance

Table 3 is the regression results of model 2, in which ownership of individual managers

(INDMO), ownership of institutional managers (INSTMO), and firm performance are

endogenous. Both ordinary and piecewise linear regressions are presented in the table.

Focus on the relation between INDMO and INSTMO first. In the ordinary linear equations

of the table, the coefficient of INDMO in the INSTMO equation and of INSTMO in the

INDMO equation are negative for both group and non-group firms. There generally exists

a substitutive relation between shareholdings of individual and institutional managers

within the structure of managerial ownership. The effect of INDMO on INSTMO is

significant only for non-group firms and differs between group and non-group firms

evident in the significantly positive coefficient of INDMO�GP. On the other hand, the

effect of INSTMO on INDMO is weakly significant for group firms ( p-value=0.123) and

exhibits a significant difference between group and non-group firms shown in the negative

coefficient of INSTMO�GP. Looking at these results from the angle of institutional

managers, they imply different roles played by the ownership of institutional managers in

different firm organizations. Compared with non-group firms, institutional managerial

ownership is relatively important to group firms because the equity interlocks via the

shareholdings of institutional managers among group members can help the group

controllers effectively manage their member firms and to entrench their private benefits.

Corresponding to this role, institutional managerial ownership is more difficult to be

Table 3

Regression results of Model 2—simultaneous-equations model of individual managerial ownership, institutional

managerial ownership, and firm performance

Variable Ordinary linear simultaneous equations Piecewise linear simultaneous equations

INSTMO

equation

INDMO

equation

Q

equation

INSTMO

equation

INDMO

equation

Q equation,

turning points—

INDMO: 3%,

15%; INSTMO:

3%, 20%

Constant 97.443

(0.003)

37.408

(0.013)

�3.545

(0.020)

64.040

(0.047)

31.374

(0.036)

�2.899 (0.044)

Q �0.855

(0.573)

1.513

(0.152)

�1.472

(0.320)

1.540

(0.133)

Q�GP �2.607

(0.101)

�1.965

(0.006)

1.051

(0.369)

�1.930

(0.006)

INDMO �1.120

(0.014)

�0.040

(0.037)

INDMO�GP 0.853

(0.000)

0.027

(0.384)

INDMA �0.137

(0.773)

0.042 (0.103)

INDMB �0.632

(0.160)

�0.056 (0.004)

INDMC �0.660

(0.136)

�0.066 (0.001)

INDMA�GP 1.224

(0.000)

�0.107 (0.001)

INDMB�GP �0.035

(0.763)

�0.043 (0.003)

INDMC�GP �0.046

(0.599)

0.021 (0.037)

INSTMO �0.068

(0.575)

�0.055

(0.127)

INSTMO�GP �0.164

(0.069)

�0.005

(0.676)

INSTMA 0.646

(0.041)

0.123 (0.018)

INSTMB �0.258

(0.133)

0.008 (0.764)

INSTMC �0.401

(0.013)

�0.028 (0.208)

INSTMA�GP 0.613

(0.080)

�0.114 (0.055)

INSTMB�GP �0.055

(0.497)

�0.048 (0.000)

INSTMC�GP �0.008

(0.876)

0.013 (0.074)

Ln(ASSET) 1.894

(0.014)

0.481

(0.361)

0.295

(0.000)

0.136

(0.839)

0.683

(0.177)

0.220 (0.000)

Ln(AGE) �33.783

(0.001)

�11.955

(0.004)

�13.907

(0.152)

�11.350

(0.006)

(continued on next page)


Variable Ordinary linear simultaneous equations Piecewise linear simultaneous equations

INSTMO

equation

INDMO

equation

Q

equation

INSTMO

equation

INDMO

equation

Q equation,

turning points—

INDMO: 3%,

15%; INSTMO:

3%, 20%

RETSD 0.243

(0.392)

0.024

(0.914)

0.315

(0.252)

0.018

(0.935)

RETSD2 �0.025

(0.155)

�0.012

(0.403)

�0.030

(0.080)

�0.010

(0.473)

DEBTA �4.542

(0.185)

2.162

(0.405)

�2.018

(0.000)

�1.555

(0.642)

1.735

(0.488)

�1.816 (0.000)

RDA 9.739

(0.310)

�3.920 (0.517)

ROA 0.855

(0.000)

0.972 (0.000)

GP �7.027

(0.000)

4.599

(0.002)

�0.225

(0.610)

�4.899

(0.003)

1.898

(0.141)

1.018 (0.000)

Adj. R2 0.931 0.926 0.740 0.934 0.929 0.752

F stat. 77.350 72.140 17.140 79.550 73.610 17.680


Q �3.462

(0.009)

�0.452

(0.596)

�0.421

(0.699)

�0.390

(0.639)

INDMO �0.267

(0.552)

�0.013

(0.755)

INSTMO �0.232

(0.123)

�0.060

(0.110)

INDMA 1.087

(0.025)

�0.065 (0.023)

INDMB �0.667

(0.133)

�0.099 (0.000)

INDMC �0.706

(0.119)

�0.045 (0.037)

INSTMA 1.259

(0.000)

0.009 (0.780)

INSTMB �0.313

(0.061)

�0.040 (0.092)

INSTMC �0.409

(0.019)

�0.015 (0.524)

p-values are in parentheses. The estimated results of a i and d t are not reported in the table.a They are calculated by adding up the coefficients of themselves and of their interaction terms with GP.

Table 3 (continued)


replaced by and more likely to substitute for the ownership of individual managers in

business-group firms.

The piecewise linear regression reports a more specific relation between ownership of

institutional and individual managers. The INSTMO and INDMO equations of Table 3

show the results when INDMO, being an explanatory variable of INSTMO, is specified as

INDMA, INDMB, and INDMC in 3% and 15% turning points, and when INSTMO in the


INDMO equation is specified as INSTMA, INSTMB, and INSTMC in 3% and 20%

turning points.5 From the coefficients of these piecewise dummies, we can find that for

both group and non-group firms, there is a complementary or positive relation between

individual and institutional managerial ownership when ownership is less than 3% (the

ranges of INDMA and INSTMA) and a substitutive or negative relation at higher levels of

ownership (the ranges of INDMB, INDMC, and INSTMB, INSTMC), with the exception

of the insignificant effect of INDMA on INSTMO for non-group firms. Almost all of these

relationships are significant at least at the one-tailed 10% significance level. Moreover, in

support of the hypothesis that the flexibility in adjusting ownership among group members

will make group firms to have a larger degree of complement or substitution between two

types of ownership, either positive or negative relationship is found to be stronger for

group firms than for non-group firms, as implied in the coefficients of the interaction terms

between GP and these piecewise dummies.

Comparing the results of ordinary and piecewise linear specification of ownership, one

may note that the finding from ordinary linear equations that INSTMO is more difficult to

be replaced by INDMO for group firms than for non-group firms is primarily caused by

that at low levels of INDMO an increase in INDMO is substantially associated with an

even larger increase in INSTMO (positive coefficient of INDMA�GP). On the other hand,

the finding that INSTMO is more likely to substitute for INDMO for group firms is due to

a stronger negative impact of INSTMO on INDMO for a large range of INSTMO

(negative coefficients of INSTMB�GP and INSTMC�GP).

The effects of Q on INDMO and INSTMO are not very important for both group and

non-group firms. The negative effect of Q shown in Table 2 only appears significantly in

the impact on INSTMO for group firms. In fact, it is difficult to conclude how the Q value

affects the ownership of both types of managers from the evidence of Table 3. Because the

Q value of a firm reflects not only the current performance but also the market expectation

on the firm’s future growth opportunities, it is not surprising that the complicated

information implied in Q will motivate diverse managerial shareholdings, and result in

empirical results that are not easy to conclude. This seems to be a question in most of

empirical studies using simultaneous-equations models to study the relation between

ownership and performance. However, the negative coefficient of Q�GP in the INSTMO

and INDMO equations suggests that there is a systematic difference between group and

non-group firms in adjusting managerial ownership to the change of market performance

of the firm. Relative to the managers of non-group firms, both individual and institutional

managers of group firms have lower ownership when the firms have higher performance.

Turning now to the effects of INDMO and INSTMO on Tobin’s Q, the Q equation

shows the impacts of both individual and institutional managerial ownership on firm

performance to have the same pattern as that implied in the impact of MO on Q in Table 2.

5 The first turning point, 3%, is the 33rd percentile of both INDMO and INSTMO for all samples. The second

turning point, 15% and 20%, are the 75th percentile of INDMO and INSTMO, respectively. I also test several

other possible linear segments, particularly 3% and 7% for both types of ownership, as the specification of MO in

Table 2. For simplicity, I do not report them in the table. However, the regression results for the 3�7% turning

points as well as others reveal the similar information as those shown in Table 3.


For both group and non-group firms, the results of ordinary linear regressions show that

either INDMO or INSTMO is negatively related to Q, and the results of piecewise linear

regressions suggest both to have low inflection points in their nonlinear relation with Q.

Specifically, for non-group firms the inflection level of ownership is higher for INSTMO

than for INDMO. While INDMB still carries a significantly negative parameter estimate,

the coefficient of INSTMB has turned to positive. Moreover, the negative impact of

INDMC is stronger than that of INSTMC. On the other hand, for group firms, the 3%

inflection point for the INSTMO’s impact is not significant and there is no inflection for

the impact of INDMO. A comparison between the effects of INDMO and INSTMO

supports the argument that an increase in the ownership of individual managers reflects the

owner’s direct intention to expropriate or to entrench. Finally, the coefficients for the

interaction terms of GP with piecewise dummies manifest significant differences between

group and non-group firms in the impacts of INDMO and INSTMO on Q. Except the

stronger entrenchment effect shown in the range between 3% and 15% of INDMO, there is

evidence to show the smoothing effect of internal capital market specific to group firms in

the three segments of INSTMO and in the segments of INDMO less than 3% and greater

than 15%.

The findings for other explanatory variables in Table 3 largely coincide with those

shown in Table 2. The coefficients of Ln(ASSET), Ln(AGE), RETSD, and RETSD2 in

both INSTMO and INDMO equations have the same signs as their effects on MO, with

some differences in the statistical significance. The role of controlling for debt issues

(DEBTA) is observed only for institutional managerial ownership. As hypothesized, the

impacts of Ln(ASSET) and ROA on Q are positive. The effect of RDA on Q is statistically

insignificant as that in Table 2. However, I have no convincing explanations for the change

in the sign of the RDA’s coefficient in two regression specifications.

The coefficient of GP is negative in the INSTMO equation and is positive in the

INDMO equation. This seems to disagree with the results of Table 1 where group firms on

the average are shown to have higher institutional managerial holdings and lower

individual ones than non-group firms. It must be noted that the impact of GP on INSTMO

is partly determined by the values of Q and INDMO, as expressed in the equation. The

significantly positive coefficient for INDMO�GP and the negative one for Q�GP in the

INSTMO equation suggest that the negative effect of group affiliation on institutional

managerial ownership will diminish as individual ownership increases or the Q value

decreases. Similarly, the negative coefficients for both INSTMO�GP and Q�GP in the

INDMO equation imply that the positive affiliation effect on the holdings of individual

managers decreases as the value of INSTMO or Q gets higher.

4.4. Additional results

Using the regression results of Table 3, we can calculate the interrelation between the

impacts of individual and institutional managerial ownership on performance. Table 4

reports the direct effect, which is the effect shown in the Q equation of Table 3, and the

total effect, which adds the indirect effect derived from the potential substitution or

complement of both types of ownership to the direct effect. Take the effect of

bINDMOV3%Q for non-group firms as an example. Its direct effect is the coefficient of

Table 4

The Impacts of individual and institutional managerial ownership on firm performance after considering the

interrelation between both types of ownership

Panel A: The effect of individual managerial ownership on Q

INDMOV3% 3%bINDMOV15% 15%bINDMO

Non-group firms

Direct effect 0.042 �0.056 �0.066

Total effect (direct effect plus

indirect effect) conditional on:

INSTMOV3% 0.025 �0.134 �0.147

3%bINSTMOV20 0.041 �0.061 �0.071

20%bINSTMO 0.046 �0.039 �0.047

Group firms

Direct effect �0.065 �0.099 �0.045



INSTMOV3% �0.055 �0.105 �0.051

3%bINSTMOV20 �0.108 �0.072 �0.017

20%bINSTMO �0.081 �0.089 �0.034

Panel B: The effect of institutional managerial ownership on Q

INSTMOV3% 3%bINSTMOV20% 20%bINSTMO

Non-group firms

Direct effect 0.123 0.008 �0.028



INDMOV3% 0.150 �0.003 �0.045

3%bINDMOV15% 0.087 0.022 �0.005

15%bINDMO 0.081 0.025 �0.002

Group firms

Direct effect 0.009 �0.040 �0.015



INDMOV3% �0.073 �0.020 0.012

3%bINDMOV15% �0.116 �0.009 0.026

15%bINDMO �0.048 �0.026 0.003


INDMA in the Q equation, which is 0.042. The indirect effect is conditional on the level

of INSTMO. Under the condition that INSTMO is less than 3%, the indirect effect is

equal to the coefficient of INSTMA in the Q equation times that of INDMA in the

INSTMO equation, that is, 0.123�(�0.137) and equal to �0.017. The total effect is thus

0.025, which is 0.042 plus �0.017.

In panel A of Table 4, the total effect of INDMO on Q has the same pattern as its direct

effect. For the total effect of INDMO in non-group firms, no matter what range of

INSTMO is, it is positive when INDMO is lower than 3%. However, the total effect is

larger than the direct effect only when INSTMO is higher than 20%. Under the condition

that INSTMO is higher than 20%, the indirect effect weakens the negative direct impact of


INDMO with the percentage higher than 3%. On the other hand, for INDMO’s total effect

in group firms, if INSTMO is higher than 3%, the indirect effect strengthens the negative

direct impact of INDMO when it is lower than 3%, but weakens that impact as INDMO is

higher than 3%. In sum, except for the situation that INDMO is less than 3% in group

firms, a sufficiently high level of institutional managerial ownership can help individual

managerial ownership exercise stronger positive or weaker negative impacts on firm

performance.

In panel B, the positive effect of INSTMO for non-group firms when it is lower than

3% is strengthened conditional on INDMO being lower than 3%, but is weakened as

INDMO gets higher. In the case that INDMO is higher than 3%, the insignificantly

positive effect of INSTMO between 3% and 20% becomes stronger and the negative effect

of INSTMO higher than 20% is weaker. It is interesting to look at the effect of institutional

managerial ownership for group firms. Because of the interaction of INSTMO with

INDMO, under all conditions of INDMO the positive effect of INSTMO at the percentage

lower than 3% turns to negative and the negative effect of INSTMO between 3% and 20%

becomes weaker. More obviously, the negative effect when INSTMO is higher than 20%

changes to positive, particularly when INDMO is lower than 15%. Compared with the

impact of individual managerial ownership in panel A, the impact of institutional

managerial ownership on firm performance is more sensitive to its interaction with the

ownership of the counterpart, particularly in the business-group firms.

5. Conclusions

Family-controlled business groups and managerial ownership held by individual and

institutional managers are two features characterizing the ownership structure of Taiwan’s

corporations. They complicate the relation between managerial ownership and firm

performance, and raise several issues rarely considered in the literature. In this paper, I

provide an empirical analysis to distinguish the impacts of individual and institutional

managerial ownership on performance in different organizations of the firm, namely,

group-affiliated and non-group independent firms. A number of findings that are different

from or not available in the prior studies based on US data are obtained.

Empirical results about the impact of ownership on performance show that there exists

a very low inflection point for the impact of managerial ownership turning from positive to

negative. An increase in managerial ownership generally reflects the strengthening of

family control or the entrenchment of controlling owners’ private benefits. Compared with

non-group firms, the organizational characteristics of business groups, such as the

mechanism of the internal capital market and the lack of transparency in the control locus,

make the performance of group firms less sensitive to the changes of managerial

ownership at low levels of ownership, and subject to the dominance of the entrenchment

effect as ownership increases. Meanwhile, the impact of ownership on performance does

not hold equally for individual and institutional managers. The inflection point for the

nonlinear ownership–performance relationship is lower for individual managerial owner-

ship, implying the increase in the ownership of individual managers to be the owner’s or

large shareholders’ direct intention to entrench. There is also evidence to show that the


mechanism of internal capital market for group firms does work in distinguishing the

impacts of both individual and institutional managerial ownership between firms with

different group affiliation. It is interesting to note that depending on the levels of

ownership, the relation between individual and institutional managerial ownership

changes. There is a complementary relation at low levels of ownership and a substitutive

one as ownership gets higher. As a reflection of the flexibility in adjusting ownership,

group firms have a larger degree of complement or substitution between two types of

ownership than non-group ones.

In sum, in addition to the findings about the relation between managerial ownership and

performance, the implications of which are different from the existent studies, this study

suggests that managers are not homogeneous in making corporate policies so that it is

necessary to identify the heterogeneity of managers in analyzing the effect of managerial

ownership on firm performance. By hypothesizing that the motivations and behaviors of

managers may vary with managerial identity and firm organizations, I conclude that in

order to arrange an efficient mix of managerial ownership, the firm owners, even though

they are controlling shareholders, should understand the relation between individual and

institutional managerial ownership, and the difference in the performance effects of both

types of ownership.

Acknowledgements

I gratefully acknowledge the financial support from Taiwan National Science Council

(NSC-90-2415-H-032-011). I also thank two anonymous referees for helpful comments

and suggestions on the early manuscript.

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