Does Ownership Concentration Affect Firm Value in Taiwan? A Panel Threshold Regression Analysis

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1 The Empirical Economics Letters, 7(7): (July 008) ISSN Does Ownership Concentration Affect Firm Value in Taiwan? A Panel Threshold Regression Analysis Feng-Li Lin Department of Accounting, Chaoyang Universy of Technology Taichung, Taiwan fengli168@gmail.com Tsangyao Chang Professor of Economics and Finance, Graduate Instute of Finance Feng Chia Universy, Taichung, Taiwan tychang@fcu.edu.tw Abstract: Using a panel of 66 Taiwanese listed companies for the period, we apply an advanced panel threshold regression model to test whether there is an optimal ownership concentration which causes threshold effects and asymmetrical relationships between ownership concentration and firm value. Market-to-book value of equy is used as a proxy for firm value. We find that the negative entrenchment effect is dominant when ownership concentration is less than 1.3% or greater than1.61%, while the 1.3% to 1.61% ownership concentration level reflects the posive incentive effect. Keywords: Market-to-Book Ratio, Panel Threshold Effect, Ownership concentration 1. Introduction The effect of ownership concentration on firm value could be eher posive or negative. A posive incentives effect may come about because large shareholders have greater power and stronger incentives to exercise effective oversight to ensure shareholder value maximization (Jensen and Meckling, 1976; Holderness and Sheehan, 1988; Lehman and Weigand, 000; Maury and Pajuste, 005). A negative effect may occur ownership concentration above a certain level leads to the entrenchment of owner-managers that expropriate the wealth of minory shareholders (Fama and Jensen, 1983; Shleer and Vishny, 1997; Faccio et al., 00; Atanasov, 005). Thus, the overall impact of ownership concentration on firm value depends upon the trade-off between incentives and entrenchment as faced by investors holding large blocks of ownership in a firm. The present study applies a panel threshold regression model to test whether there is an optimal level of ownership concentration at which point the threshold effect and asymmetrical relationship between ownership concentration and firm value may be determined. In contrast to tradional linear models, this nonlinear threshold model is able

2 The Empirical Economics Letters, 7(7): (July 008) 674 to determine whether the posive incentive effect or the negative entrenchment effect dominates. Taiwan is characterized by highly concentrated ownerships, a lower level of investor protection, and influential large shareholders who presumably have considerable incentives to oversee managers. Thus, Taiwan provides a natural setting for examining the influence of ownership concentration on firm value. The paper proceeds as follows. Section provides the sample data and the variables and describes the methodology. Section 3 discusses the empirical results, and Section 4 concludes.. Data and methodology.1. Sample description We use a balanced panel data selected Taiwan Stock Exchange (TSE)-listed companies in Taiwan covering the period from 1996 to 006 obtained from the Taiwan Economic Journal (TEJ) database of Taiwan. We exclude financial and insurance firms, because the nature of capal and investment in these industries is not comparable to those of nonfinancial firms. The final sample is 66 public trading companies, distributed across the eighteen industry sectors as follows: Electron (55), Textiles (30), Plastics (18), Steel and Iron (18), Construction (18), Chemical (17), Food (16), Transportation (1). The residual 8 companies are from the remaining sectors... Variables As the proxy for firm value, we adopt the ratio of market-to-book value (MTB) which is the most common measure in empirical corporate governance research (e.g., Morck et al.,1988; Himmelberget al.,1999) rather than accounting-based measures because takes risk into account and is not as likely to distort the results as other measures, such as the return on assets (Lindenberg and Ross, 1981). The threshold variable, ownership concentration (OC), the percentage of equy owned by the top 10 largest shareholders who are non-managerial and non-board members, is the key variable that we use to investigate whether there is an asymmetric threshold effect of ownership concentration on firm value. We also include four control variables commonly used in the analysis of firm value, namely, the natural log of the book value of total assets (Size) to capture intangibles related to the firm s size; the ratio of total liabilies to total assets (Leverage); the rate at which a firm is growing (Growth), which is calculated as the annual percentage change in sales; and the ratio of annual change in net fixed assets to that of total assets (Capal spend). Table 1 presents the MTB is more evenly distributed wh a pooled mean (median) of 1.57 (1.17). The pooled mean (median) OC is 13.84% (1.5%). As for the control variables, on average for the pooled sample, the Leverage is 40.1%, the Sales growth is 9.9%, the

3 The Empirical Economics Letters, 7(7): (July 008) 675 Capal spend is 3.54%, total assets distribution is also skewed by the large dferences between mean (1858million NT$) and median ( million NT$). On the basis of the Jarque-Bera test results, we reject the normaly of all the variables..3. Research Methodologies.3.1. Panel Un Root models Hansen s (1999) panel threshold regression model requires that the variables in the model be stationary in order to avoid spurious regressions and go further estimations of the panel threshold regression. Thus, we first perform the panel un root test by the Levin-Lin-Chu (LLC) (Levin et al., 00), the Im-Pesaran-Shin (IPS) (Im et al., 003), the Augmented Dickey-Fuller (ADF)(Dickey and Fuller,1979), and the PP - Fisher Chi-square (Phillips and Perron, 1988) approaches. Based on the results of the un root test of each panel, the variables have stationary characteristics since the nulls of the un root are mostly rejected. Table 1: Sample Descriptive Statistics Variables Mean Std. Dev. Maximum Median Minimum Jarque-Bera MTB *** OC *** Leverage *** Sales growth *** Capal spend *** Total assets (New Taiwanese $ millions) *** Notes. The sample size is 66 firms for each of the period and is a total of 96 firm-year observations results. MTB is measured as the ratio of market-to-book value of equy. Ownership concentration (OC) is defined as percentage of total stock held by the top 10 largest shareholders who are non-managerial and non-board members. Leverage is measured as the ratio of total liabilies to total assets. Sales growth is calculated as the annual percent change in sales. Capal spend is measured as the ratio of annual change in net fixed assets to that of total assets..3.. Panel Threshold Autoregressive Model We introduce the procedures 1 briefly as follows. According to Hansen (1999), we set up the panel threshold regression model wh fixed effects as follows: 1 For the detailed illustration, please refer to Hansen (1999).

4 The Empirical Economics Letters, 7(7): (July 008) 676 µ ω + α1t + ε κ = µ ω + α T + ε t ( λ1, λ, λ3, λ4 ), = λ = ω T T γ > γ ( s, l, g, c ) where κ represents firm value, and the ratio of market-to-book value (MTB) is used as the proxy; T, ownership concentration, is a threshold variable; and γ is the specic estimated threshold value. There are four control variables ( ω ) that may affect firm value, and these are s : Size; l : Leverage; g : Sales growth; c : Capal spend. Besides these, there is µ i : the fixed effect which represents the heterogeney of companies under dferent operating condions. We assume the errors ε are independent and identically distributed, wh the mean zero. The fine variance is σ ( ε ~ iid(0, σ ) ); i represents dferent companies; and t represents dferent periods. For the estimation procedures, we first eliminate the individual effect µ i using the whin transformation estimation techniques in the tradional fixed effect model of panel data. By using the ordinary least squares and minimizing the concentrated sum of squares of errors, S ( ), we can obtain the estimators of our threshold value and the residual variance, γˆ and 1 γ ˆ σ, respectively. For the testing procedures, first, we have to go on to test the null hypothesis of no threshold effect, H : α = α 0 1, which can be based on the likelihood ratio test: ( S0 S1( ˆ) γ F1 =, where S ˆ σ 0 and S 1( ˆ γ ) are sum of squared errors under null and alternative hypotheses, respectively. However, as the asymptotic distribution of F 1 is nonstandard, we use the procedure of bootstrap to construct the crical values and p-value. Upon the existence of threshold effect, H 0 : α1 α, we should test for the asymptotic distribution of threshold estimate, H 0 : γ = γ 0, and adopt the likelihood ratio test: ( S1( γ ) S1( ˆ) γ LR1 ( γ ) = wh the asymptotic confidence intervals : ˆ σ t ( ) log( 1 1 α ) c α =. Furthermore, the single threshold is indeed exists, we can extend the panel threshold regression model wh single threshold to the double as follows: (1) Note that LR 1 ( γ 1 ) is testing for H 0 : γ = γ 0, while F 1 is testing H 0 : α 1 = α.

5 The Empirical Economics Letters, 7(7): (July 008) 677 µ ω + α1t + ε κ = µ ω + α T + ε µ ω + α 3T + ε γ < T γ 1 γ 1 < T γ T > γ where threshold value. Following the same procedure, we can go further to the ones wh triple or multiple thresholds: γ γ, γ, Lγ 3. Empirical Results 1 γ 1, 3 n. We follow the bootstrap method proposed by Hansen (1999) to obtain the approximations of the F statistics and then calculate the p-values. The bootstrap procedure is repeated 1000 times for each of the three panel threshold tests. Table presents the test statistics F 1, F, and F 3, along wh their bootstrap p-values. We find that the test for a single threshold F 1 and a triple threshold F 3 is insignicant wh a bootstrap p-value of 0.36 and 0.618, respectively; only the test for a double threshold F is signicant wh a bootstrap p-value of Thus, we conclude that ownership concentration has two threshold effects on firm value. The point estimates of the two thresholds ( ˆ γ 1 and ˆ γ ) are 1.3% and 1.61% and they separate all of the observations into three regimes. Table : Tests for Threshold Effects Single threshold effect test Double threshold effect test () Triple threshold effect test Threshold -value F p-value * Crical Value of F 1% % % Notes: F Statistics and p-values result from repeating the bootstrap procedure 1000 times for each of the three bootstrap tests. ***, ** and * represent signicance at the 1, 5 and 10% levels, respectively. Table 3 illustrates the coefficients of three regimes, ˆα 1, ˆα, and ˆα 3, all signicant at the 1% level, while only ˆα is posive. In the first regime, where the ownership concentration is less than 1.3%, the estimate of coefficient ˆα 1 is , which indicates that a 1% increase in the ownership concentration decreases market-to-book ratio by 0.083%. In the second regime, where the ownership concentration is greater than 1.3% and less than

6 The Empirical Economics Letters, 7(7): (July 008) %, the estimate of coefficient ˆα is , which denotes that a 1% increase in the ownership concentration increases market-to-book ratio by %. In the third regime, where the ownership concentration is greater than 1.61%, the estimate of coefficient ˆα 3 is , which implies that a 1% increase in the ownership concentration decreases market-to-book ratio by %. Therefore, the negative entrenchment effect is dominant when ownership concentration is less than 1.3% or greater than1.61%, while the 1.3% to 1.61% ownership concentration level reflects the posive incentive effect. Table 3: Estimation of Coefficients Coefficient Estimate OLS SE t OLS Whe SE t Whe ˆα *** *** ˆα *** ˆα *** *** 3 Note: 1 ˆα, ˆα and ˆα 3 are the estimated coefficient for regimes of Τ > γˆ. Τ, γˆ1 ˆ γ < Τ γ and 1 ˆ In the estimations of the coefficients of the control variables, shown in Table 4, we note that firm Size is signicantly and negatively related to market-to-book ratio. The interpretation here is that larger firms can be less efficient than smaller ones because of the loss of control by top managers over strategic and operational activies whin the firm (Himmelberg et al., 1999). The Leverage is signicantly and posively related to marketto-book ratio and, stated briefly, the higher the leverage that a firm has, the higher is s firm value. This result is consistent wh the argument in the areas of corporate tax (Modigliani and Miller, 1963) and information asymmetry (Ross, 1977). Finally, Sales Growth and Capal Spend are not signicantly related to market-to-book ratio. Table 4: Estimation of Coefficients of Control Variables Coefficient Estimate OLS SE t OLS Whe SE t Whe θ *** *** θ *** θ θ Notes:***, ** and *, represent signicance at the 1, 5, and 10% levels, respectively. θ 1, θ, θ 3 and θ 4 represent the estimated coefficients: Size, Leverage, Sales Growth and Capal spend.

7 The Empirical Economics Letters, 7(7): (July 008) Conclusion In this study, using Hansen s (1999) panel threshold regression model, we find that there are two threshold effects between ownership concentration and firm value in Taiwanese companies during the period, and these are 1.3% and 1.61%. When the ownership concentration is less than 1.3% or greater than 1.61%, the negative entrenchment effect is dominant. While the 1.3% to 1.61% ownership concentration level reflects the posive incentive effect, a 1% increase in the ownership concentration increases market-to-book ratio by %, which predicts that ownership concentration of top10 shareholders have greater power and stronger incentives to exercise effective oversight to ensure shareholder value maximization (Jensen and Meckling, 1976). Our results shed light on the functioning of corporate governance, particularly, on the role of ownership concentration and investor protection. Our results should also provide a new perspective for the ongoing debate on corporate governance reforms. References Atanasov, V., 005, How much value can blockholders tunnel? Evidence from the Bulgarian mass privatization auctions, Journal of Financial Economics, 76, Dickey, D.A.and W.A. Fuller, 1979, Distribution of the estimators for autoregression time series wh a un root, Journal of American Statistical Association, 74, Fama, E. F.and M. C. Jensen, 1983, Agency problems and residual claims, Journal of Law and Economics, 7, Faccio, M.and L.Lang, 00, The ultimate ownership of Western European corporations, Journal of Financial Economics, 65, Holderness, C.G.and D.P. Sheehan, 1988, The role of majory shareholders in publicly held corporations: an exploratory analysis, Journal of Financial Economics, 0, Hansen, B. E., 1999, Threshold effects in non-dynamic panels: estimation, testing and inference, Journal of Econometrics, 93, Himmelberg, C., R. Hubbard and D.Palia, 1999, Understanding the determinants of managerial ownership and the link between ownership and performance, Journal of Financial Economics, 53, Im, KS., M. H. Pesaran and Y.Shin, 003, Testing for un roots in heterogeneous panels, Journal of Econometrics, 115, Jensen, M.C.and W. H. Meckling, 1976, Theory of the firm: managerial behavior, agency cost and ownership structure, Journal of Financial Economics,3,

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