This book is a staff product of the International Bank for Reconstruction and Development / World Bank. The World Bank does not guarantee the accuracy of the data included in this work.
Acknowledgments
We would like to thank Rose Vo for her assistance in obtaining the copyrights of the articles from the authors and publishers, Joaquin Lopez for his technical assistance in reproducing the articles, Stephen McGroarty from the Office of the Publisher of the World Bank for his assistance and guidance in publishing the book, and the World Bank for financial support. The views presented in these published articles are those of the authors and should not be attributed to, or reported as reflecting, the position of the World Bank, the International Monetary Fund, the Executive Directors of either organization, or any other organization mentioned therein. .
Introduction
Part I. Law and Finance
Taking a much more micro approach and using data on private equity investments in developing countries, they show that investments in high-enforcement, common-law countries often use covenant convertible preferred stock, while investments in countries with low enforcement and civil law tend to use common stock and debt and rely on equity and board control. In other words, low enforcement environments force investors to use less-than-optimal contracts to secure their ownership and control rights, which makes business operations less efficient.
Part II. Corporate Governance
The private benefits of control for the controlling shareholder are often substantial, especially in environments where shareholder rights are low. Legal institutions plus enforcement and media pressure appear to be important factors in limiting private benefits of control.
Part III. Banking
In Chapter 10, "The Value of Durable Banking Relationships: Evidence from Korean Banking Shocks," Kee-Hong Bae, Jun-Koo Kang, and Chan-Woo Lim examine the value of durable banking relationships in the Republic of Korea, using a sample of exogenous events that negatively affected Korean banks during the financial crisis of 1997–98. The authors show that adverse shocks to banks have a negative effect not only on the value of the banks themselves, but also on the value of their client firms.
Part I. Capital Markets
They also show that this negative effect on firm value is a decreasing function of the financial health of both banks and their customers. They then show that the economic efficiency of a firm's investment, as measured by Tobin's Q (the ratio of the market value of a firm's assets to the replacement value of its assets—a measure of firm efficiency and growth potential), is positively related to the magnitude of firm-specific variation in stock returns, suggesting to the fact that more informative stock prices enable more efficient corporate investments.
Part II. Capital Structure and Financial Constraints
In addition to being a limited way to control for cross-country differences, another complication of studying the determinants of capital structure is that not all firms seek external finance. The authors find that financial and institutional development weakens the restrictive effects of financing constraints on firm growth in an economically and statistically significant way and that it is smaller firms that benefit most from greater financial sector development.
Part III. Political Economy of Finance
PROPERTY RIGHTS is an index of the extent to which the government enforces laws that protect private property. The law and endowment theories emphasize the extent to which national institutions emphasize private property rights versus the rights of the state.
ARTICLE IN PRESS
Furthermore, SETTLER MORTALITY takes all PROPERTY RIGHTS regressions negative and significant, except those including continent dummies. However, FRENCH LEGAL ORIGIN is negatively and significantly associated with PROPERTY RIGHT in all regressions when controlling for SETTLER MORTALITY. SETTLER MORTALITY appears significantly in all PRIVATE CREDIT and STOCK MARKET DEVELOPMENT regressions, but does not appear significantly in the PROPERTY RIGHTS regression when controlling for AFRICA.
An assessment of property rights in each country (on a scale of 1 to 5). The more protection private property receives, the higher the score. Chile scores e.g. high in property rights protection (with a property rights index of ¢ve), but its level of financial development is only average (reflected by a level of private credit to GDP of 36%). This suggests that the results are not due to the particular property index chosen.
DOES LEGAL ENFORCEMENT AFFECT FINANCIAL TRANSACTIONS? THE CONTRACTUAL CHANNEL IN
PRIVATE EQUITY*
T HE D ATA
This table summarizes key characteristics related to the composition of the sample of 210 private equity transactions. The first panel describes the characteristics of the transactions; the second panel, country and private equity group characteristics involved in the transaction. Finally, the board structure is little different from that of the United States.
Taken together, these results suggest that private equity groups rely on either (a) protection of minority shareholders through detailed specification of conduct that is excluded, or (b) control through majority ownership of common stock and dominance of the board .
Disentangling the Incentive and Entrenchment Effects of
Large Shareholdings
Sample Selection and Data
Owned by a Widely Held Corporation or financial institution. A limit of 10 percent for effective control over the largest shareholder. The mean and median market-to-book ratios of the sample companies are shown in Table III. The market-to-book value is the ratio between the market value of the assets and the book value of the assets at the end of 1996.
Market value is defined as the sum of the market value of common shares and the book value of debt and preferred shares.
Ownership and Control Concentration and Their Effect on Firm Value
The value of the firm, as measured by the market-to-book ratio, generally increases with the fraction of cash rights in the hands of the largest owner. Company valuation and the difference between control and ownership of the largest shareholder in East Asian corporations, 1996. Control minus ownership is a continuous variable that measures the simple difference between the share of control rights and the share of low rights of cash in hand. of the largest shareholder.
Control minus ownership is a continuous variable that measures the simple difference between the proportion of control rights and the proportion of cash flow rights in the hands of the largest shareholder.
Owner Types and Mechanisms for Separating Ownership and Control
A pyramid is a dummy equal to one if the firm is part of a pyramid structure, including if the firm is at the top of the pyramid, and zero otherwise. Control exceeds ownership is a virtual entity if control rights are higher than cash flow rights; otherwise it is nothing. A pyramid is a dummy equal to one if the company is part of a pyramid structure; otherwise it is nothing.
Dual class is a dummy equal to one if the firm has issued dual class shares; otherwise, it is zero.
Conclusion
Claessens, Stijn, Simeon Djankov and Larry Lang, 2000, The Separation of Ownership and Control in East Asian Firms, Journal of Financial Economics58, 81-112. Grossman, Sanford and Oliver Hart, 1988, One-share, one-vote, and the market for corporate control, Journal of Financial Economics20, 175-202. Morck, Randall, Andrei Shleifer and Robert Vishny, 1988, Managerial Ownership and Market Valuation: An Empirical Analysis, Journal of Financial Economics20, 293-315.
Stulz, René, 1988, Managerial control of voting rights: Financial policies and the market for corporate control, Journal of Financial Economics 20, 25–54.
Private Benefits of Control: An International Comparison
Theoretical Framework A. What Are Private Benefits of Control?
Another traditional source of private control benefits is the benefits enjoyed by top executives (Jensen and Meckling (1976)). As we will show shortly, this difference (which we will call the control premium) represents an estimate of the private benefits of control enjoyed by the controlling party. In a perfectly competitive market (λ=1), ˆB collapses to Bband, making the control premium a legitimate estimate of the private benefits of control that the buyer expects to enjoy.
Therefore, ˆBdevalues the value of the private benefits by the difference in the value of the security the sum of the value of the security contained in the control block (α).
Data and Descriptive Statistics
The difference between the security value of the buyer (market price at t+2) and that of the seller (market price att−30), normalized by the market price att+2. A proxy for the buyer's bargaining power is the announcement return experienced by the buyer of the controlling block. Finally, the level of private benefits obtained could be endogenous to the size of the controlling bloc.
In Brazil, we estimate that private benefits amount to 65 percent of the value of equity capital.
Effects of Private Benefits on Financial Development A. Theoretical Predictions
We start by focusing on the relationship between the size of private benefits and ownership concentration (Specification 1). A one standard deviation increase in the size of private benefits translates into 11 percent more of the equity of the three largest shareholders in the instrumental variables specification. In specification 2, we test the effect of private benefits on the way firms are privatized.
Private benefits also explain a significant portion of the cross-sectional variation in these measures.
What Curbs Private Benefits of Control?
A one standard deviation increase in the size of private benefits leads to 36 percent more firms being privatized through private negotiations in the instrumental variables specification. In Table VII, panel B, we test the relationship between private benefits and capital market development, starting with the various aggregate indicators of financial development used by La Porta et al. Our measure of private benefits is significant in all regressions, with the exception of the OLS specification with the number of listed firms, where the single data point of Israel, with an unusually high level of number of firms, reduces our level of significance.
All regressions include log GDP per capita as a regressor, to control for other possible factors.25 A standard deviation increase in private benefits translates into a 67 percent decrease in the share of capital external capitalization/.