Effect of government share ownership on corporate risk taking

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Research in International Business and Finance

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Effect of government share ownership on corporate risk taking: Case of the United Arab Emirates ^夽

Md Hamid Uddin

CollegeofBusinessAdministration,UniversityofSharjah,P.O.Box27272,Sharjah,UnitedArabEmirates

a r t i c l e i n f o

Articlehistory:

Received22May2015 Accepted23September2015 Availableonline28September2015

Keywords:

Governmentownership Corporaterisktaking Principal–principalconflict

a b s t r a c t

Ifgovernmentholdsownershipincorporatefirms,principal–principalconflictmayarise betweengovernmentandprivateowners.Iargueconflictaggravateswhengovernment isminorityowner,becausethepowerfulminorityowner(government)exertspolitical pressureonthemajorityprivateownerstoachievegovernmentobjectives.Hence,gov- ernmentminorityfirmsarelikelytobeconservativeinrisktakingduetotheexistenceof principal–principalconflict.IprovidesupportingevidencefromtheUnitedArabEmirates, whichhasthehighestrecordofgovernmentownershipinstockexchangelistedfirmsof anycountry.However,therelationshipbetweengovernmentownershipandrisktakingis anon-linearU-shaped.

©2015ElsevierB.V.Allrightsreserved.

1. Introduction

Governmentorstatecorporateownershipisfoundacrosstheworld(Claessensetal.,2000;DewenterandMalatesta, 2001;Boubakrietal.,2013a),butthisphenomenonisespeciallywidespreadintheUnitedArabEmirates(UAE),where governmentmaintainsashareownershipin48%ofallthestockexchangelistedfirms(Uddinetal.,2014).Thisisperhaps thehighestdocumentedrecordofgovernmentownershipinthestockmarketlistedfirmsofanycountry.Differentstudies reportthatthegovernmentshareownershipnegativelyaffectsthecorporateperformanceindifferentcountriessuchas Singapore,Malaysia,China,Turkey,India,andJordan(AngandDing,2006;Fengetal.,2004;NajidandRahman,2011;Tian andEstrin,2008;SunandTong,2002;GursoryandAydogan,2002;Gupta,2005;ZeitunandTian,2007).Theseresearchers mainlysuggestthatanegativerelationshipbetweenthegovernmentownershipandfirmperformanceistheresultofthe agencyproblem.Interestingly,Uddinetal.(2014)documentthatgovernmentownershiphasgenerallyapositiveeffect onthecorporateperformanceintheUAE,whichisinconsistentwiththeevidenceoftheothercountries.Thisanomaly motivatesmetoexaminethedynamicsoftherelationshipbetweenthegovernmentandthecorporatefirminwhichthe governmentmaintainsanownership.

Giventheabovebackground,Ibelievethatthegovernment,asthemostpowerfulpoliticalinstitutionofacountry,having anownershipinafirmdirectlyinfluencesitsrisk-takingdecisions(henceforthcorporaterisktaking),whichdeterminesthe performance,survival,andgrowthofthatfirminthecompetitivemarketenvironment(NakanoandNguyen,2012;Memili etal.,2010;Gilleyetal.,2002;Bromiley,1991).Thegovernmentinfluencescorporaterisktakingdecisionsbecauseithas

夽 ThispaperwasdevelopedwithnecessarydatabaseandotherresearchsupportsavailableattheUniversityofSharjah.Theearlierversionofthispaper wasacceptedforpresentationatWorldFinanceConference,21–24July,2015BuenosAires,Argentina.Authoracknowledgesthecommentsandsuggestions receivedfromseveralcolleaguesatdifferentstagesofresearchimplementation.

E-mailaddresses:ibahu@yahoo.com,mduddin@sharjah.ac.ae http://dx.doi.org/10.1016/j.ribaf.2015.09.033

0275-5319/©2015ElsevierB.V.Allrightsreserved.

social,political,andeconomicinterestsinthefirm(Wrightetal.,1996;Johnetal.,2008;Boubakrietal.,2013a;Uddin, 2014).Thesocialandpoliticalinterestsaremainlyrelatedtopublicemployment,socialstability,andpoliticalcontroloverthe economy,whilsttheeconomicinterestsarerelatedtosupplementinggovernmentrevenuebyadditionaldividendsincomes, capitalgains,andcorporatetaxes(Uddin,2014).Sincethestockmarketlistedfirmsusuallymaintainadiffusedownership structure,thegovernmentworkswithothershareholderstodevelopagovernancemechanismthatissupposedtoalignthe interestsofdifferentshareholdergroups(Suretal.,2013).However,Iassumethatalignmentofallshareholders’interests isdifficultbecauseofthediversityofinterests.Consequently,themajorand/orpowerfulshareholders’interestsultimately determinethecorporate risktakingbehaviorofafirm. Sincegovernmentispoliticallythemostpowerfulshareholder regardlessofthelevelofownership,thecorporaterisktakingofthefirmwithashareholdingofthegovernmentwillreflect theinterestsofgovernmentallelse thesame.Therefore,arelationshipbetweenthegovernmentshareownershipand corporaterisktakingisexpected.

Basedonacross-countrysample,Boubakrietal.(2013a)recentlyreportedthatgovernmentownershiphasanegative effectoncorporaterisktaking.Thisincitesmetothinkifthegovernmentownershipinevitablydiscouragesafirmfrom takingmorerisksthenwhydoesthestudyofUddinetal.(2014)findthattheUAEgovernmentlinkedcompanies(GLC) performbetterthanthefirmswithoutgovernmentlinks.Therefore,anewstudyongovernmentownershipandcorporate risktakingisundertakenbasedontheUAEdata.Theliteraturereviewshowsthatthefirmowners,particularlytheinsiders, havebothnegativeandpositiveincentivestoundertakeriskyinvestments.Thefirmisconservativeinrisktakingifthe governmentasaninsiderowneractivelyseekstoachieveitssocialand politicalobjectives,whereas thefirm liberally takesriskifthegovernmentgivesprioritytotheeconomicobjectivesandprovidesactivesupporttothefirm.Therefore, governmentshareholdingcanhaveeitheranegativeorapositiveeffectonthecorporaterisktaking,subjecttothepriorityof governmentobjectives.Giventhisknowledge,basedonthetheoryofprincipal–principalconflict,Ianalyzethatgovernment getsintodisputeswiththeprivateshareholdersifthemajoritysharegoesoutofthegovernmenthands.Thisoccursdue todivergenceoftheinterestsinthefirmmaintainedbytheminoritygovernmentandthemajorityprivateowners.The discordbetweenthemaggravateswhenthepowerfulminority,beingthegovernment,exertspressuresonthemajorityto achievethegovernmentobjectives,andinthestateofhighconflict,thegovernmentminorityfirmwillbeconservativein takingonriskyprojects.However,whengovernmentmaintainsthemajorityownership,theconflictofinterestsbetween thegovernmentandprivateownersisless,andtherisktakingdecisionscanbemademoreeasilyifneededforthecountry, giventhecircumstancesoftheeconomy.Finally,Ihypothesizethattherelationshipbetweenthelevelofgovernmentshare ownershipandcorporaterisktakingwillexhibitanon-linearU-shapedpatterninsteadoflinearity.

Using10years’datafrom108firmslistedontheDubaiFinancialMarket(DFM)andAbuDhabistockexchange(ADX) andfouralternativemeasuresofcorporaterisktaking,IfindthattheidentityofafirmasGLC(firmshavinggovernment ownership)doesnotsignificantlyaffectitscorporaterisktaking.Comparedwiththenon-GLCs(firmshavingnogovernment ownership),theGLCstakemoreriskwhengovernmentmaintainsfullcontroloverthefirmbyholdingmorethan50per- centownership.Finally,theregressionsidentifyasignificantlyquadraticrelationshipbetweengovernmentownershipand corporaterisktaking,inwhichthefirstordereffectofthegovernmentownershiponrisktakingisnegativebutthesecond ordereffectispositive,confirmingthetesthypothesis.Iconfirmtheresultsbyconductingadditionalteststhatexamine therobustness.Asawhole,theeffectofgovernmentownershiponthecorporaterisktakingbehaviorintheUAEisnot consistentwiththeonlyavailableevidencerecentlyprovidedbyBoubakrietal.(2013a)basedonthecross-countrydata.

Thecross-countrystudyreportsthatthegovernmentshareownershipmonotonicallyleadstolowercorporaterisktaking bythefirm,whereasthecurrentsinglecountrystudyshowsthatthepropensityofcorporaterisktakinginitiallydeclines withtheincreaseingovernmentownershipbutrisesifthegovernmentstronglyparticipatesinthefirmownershipwith fullcontrolonthefirm.

Thefindingsofmystudyhaveseveralimplications.First,anewcorporategovernancemechanismcanaligntheinterests ofthegovernmentandprivateownersoftheGLCs.Second,theGLCmanagersshouldmakevalue-addingcorporatedecisions withacarefulbalanceoftheinterestsofthegovernmentandprivateowners.Third,theinvestmentmanagersshouldselect theGLC stockswithmoreanalysesonthefuturegrowthprospectsofthefirmshavinggovernmentownership.Fourth, privatizationwithouteffectivetransferofthecontroloffirmstotheprivateshareholderswillnotbesuccessfultoimprove firmperformanceduetotheriseofconflictbetweenthegovernmentandprivateowners.Theresultsalsosuggestthat majorityorcontrollinggovernmentownershipofafirmisnottobeconsideredbadifGLCscanbemanagedbytheprofessional managerswithahighstandardofcorporategovernanceandwithoutpoliticalmotive.¹Thisstudycontributestotheliterature byprovidinganewanalysistounderstandthebehavioroftherelationshipbetweengovernmentownershipandcorporate risktakingandbydocumentingthefirstsinglecountryevidencethattheminoritygovernmentshareownershiphasa negativeeffectonthecorporaterisktaking,butthemajoritygovernmentownershiphasapositiveeffectonrisktaking.I believethattheUAEevidenceisanimportantadditiontotheliterature,becausethiscountryhasdistinctcharacteristics thatjustifyanewstudyabouttheeffectofgovernmentownershiponcorporaterisktaking.

TheUAEisthesecond-richestcountryintheworldintermsofthevalueoftotalsovereignwealthfundsinvested($975 billion)inrealandfinancialassetsacrosstheworld,includingthehomecountry(Source:GulfTodayMay7,2014).Asreported

1IntheUAE,themajorityofCEOsoftheGLCsdonotplayadualroleastheboardchairman(Uddinetal.,2014).Anongoinginvestigationshowsthat manyoftheseCEOsareprofessionallytrainedpeoplerecruitedfromglobaltalent.

bytheSovereignWealthFundInstitute(SWI),thishugegovernment-ownedpoolofmoneywasgeneratedfromoilrevenue andaccumulatedasthebudgetarysurplusofmanyyears.Thisfundismanagedbysevenprofessionalinvestmentagencies belongingtotheUAEfederalandstategovernments(Source:http://www.swfinstitute.org,accessedNovember16,2014).The governmenthasbeenworkingtofullydiversifytheeconomyby2030inordertohedgeagainsttheoilincomerisk(Source:

http://aviationweek.com/awin/uae-industry-builds-capability,accessedNovember18,2014).Asofnow,thediversification oftheeconomyraisesthenon-oilshareofGDPto71%duetomassivegovernmentinvestmentsinthecorporatesectors (Source:GulfNews,November18,2014),whichresultsinthehighestrecordofgovernmentownershipinthefirmslistedon thetwolocalstockmarkets(Uddinetal.,2014).Duetomassivegovernmentinvestmentinthenon-oilcorporatebusinesses, theannualgrossdomesticproduct(GDP)oftheUAEhasbeenincreasedrapidlyto$416billionasofOctober2014–ranking theUAEasthe30thlargesteconomyoftheworldandthesecondlargestintheMiddleEastwithapercapitaincomeof

$44,552(Source:InternationalMonetaryFund).AlthoughtheUAEisanemergingcountry,thegovernmenthasmaintained efficiencyandprofessionalisminmanagingtheeconomy.Thishasbeenwitnessedbyitshighstanding(ranked12th)inthe GlobalCompetitivenessIndexof2014–2015(Schwab,2014).Asawhole,itisunderstoodthatthegovernmentinvestment intheUAEhasplayedanimportantroletodevelopthecorporatebusinessesofthecountry.Therefore,thisstudyisatimely attempttoinvestigatehowanactiveparticipationofthegovernmentincorporatebusinessesaffectstherisktakingofthe UAEfirms.

Therestofthepaperisorganizedasfollows:inthenextsection,relevantliteratureisreviewedtounderstandhowthe governmentbeinganinsidercaninfluencetherisktakingdecisionsofthecorporatefirmsandtherebyaffectcorporaterisk taking.Inthesubsequentsections,thesamplecharacteristics,testvariablesandempiricalfindingsaredescribed.Finally, conclusionsareprovidedinthelastsection.

2. Literatureandhypotheses

Thelevelofgovernmentinvolvementintheeconomymanagementisadebatableissue.Inanidealmarketeconomy, thegovernmentframespoliciesandlaws,enforcesrights,andtakesmeasurestoreducemonopoliesthatblockthemarket entryofnewfirms(Friedman,1962).Yetthegovernmentownsandmanagesbusinessenterprisesacrosstheworlddue topoliticalandeconomiccircumstances.Inmostcountries,thegovernmentundertakesinvestmentprojectsbysettingup wholly-ownedfirmsduringtheearlystagesofeconomicdevelopmentandtransfersownershiptoprivateownersthroughfull orpartialprivatizations;manyoftheseprivatizedfirmsarelistedonthestockexchanges(Uddin,2014).Insomecountries, thegovernmentinvestssovereignfunds(budgetsurplus)inthestockmarketlistedfirmsthroughtheirownagencies.² Governmentalsoprovidesventurecapitaltostartupcompanies(Lerner,1999)thateventuallycometothestockmarkets.

Therefore,governmentbecomesashareownerofthestockmarketlistedcorporatefirmsthroughtheprivatizationprogram, sovereignfundinvestment,andventurecapitalfinance.

Inowfocusonhowgovernmentinfluencestherisktakingdecisionofafirm.Wrightetal.(1996)arguethatshareholders prefergrowth-orientedrisktaking,buttheinsiderownerswhodirectlyparticipateinfirmmanagementoftenavoidsuch risktakingbecausetheinsiders’interestdependsontheirtotalwealthportfolios,pecuniaryandnon-pecuniarybenefits, andchancesofentrenchment.Theyanalyzethattheinsiderowners’capitalinvestedinafirmrepresentsasignificantpro- portionoftheirtotalwealththatresultsinundiversifiedpersonalwealth.Hence,theinsiderownershavingundiversified personalwealthmaymakecorporaterisktakingdecisionsbasedontheanalysisoftheirpersonalgainsandlossesandmay acceptthelow-risk,non-value-maximizingprojects.Althoughgrowthofafirmisbeneficialforallshareholdersincluding insiders,theuncertaintiesassociatedwiththegrowth-orientedprojectsmayreducetheinsiders’incentivestotakehigh risksthatmayaffecttheirpecuniaryandnon-pecuniarybenefits.Thereby,insiderownersmaypreferentrenchmentoftheir positioninthefirmbyavoidingrisktaking.Suchriskavoidancebehaviorofthecorporateinsidersbecomesstrongerifthe financialsystemislessdeveloped,corporategovernancestandardsareweak,andinvestorsarelessprotected(Durnevetal., 2004;Wurgler,2000).Ontheotherhand,itcanalsobearguedthatinsiderownerswhoareinvolvedinthemanagement ofafirmmayprefertakingrisksifthegrowthoffirmvaluationisimportantforthem.Thishappensparticularlywhen afirmisunderthe(i)threatofhostiletakeover(Hasbrouck,1985;MartinandMcConnell,1991;Sinha,2004),(ii)influ- enceofcapitalmarketsignalingeffectsduetoimprovementoffirmearningsanddividendspayments(Easterbrook,1984;

Bhattacharya,1979;Benartzietal.,1997),and(iii)astrongregulatoryregimeprotectingtheinterestsoftheshareholders– becausestronginvestors’protectionreducesthemagnitudeandimportanceofprivatebenefitstotheinsiders(Johnetal., 2008).

Therefore,theabovestudiesshowthatthecorporateinsiderswhoareinvolvedinthemanagementoffirmshaveboth negativeandpositiveincentivesfortakingrisks.Animportantissuehereisthattherearedifferentcategoriesofinsiders,e.g., thefoundingperson(s)/family,government,venturecapitalists,financialinstitutions,andmanagerswhositontheboard andplayactiverolesincorporatedecisionmaking.Whiletheagencytheoryaddressestheconflictofinterestsbetween thecorporatemanagersandshareholders,itisalsolikelythatconflictsexistamongtheinsidersduetodivergenceoftheir

2 TemasekHoldings,GovernmentofSingaporeInvestmentCorporation,AbuDhabiInvestmentAuthority,AbuDhabiInvestmentCouncil,Investment CorporationofDubai,EmiratesInvestmentAuthority,ChinaInvestmentCorporation,andKuwaitInvestmentAuthorityareexamplesofgovernment investmentagenciesofSingapore,UAE,ChinaandKuwait.

interestsinthefirm(Gilletteetal.,2003).Thisissueisparticularlyimportantinthisstudy,becauseitintendstoexplain(i) howthegovernment,asthemostpowerfulpoliticalinstitutionofthecountry,workswithotherinsidersinthefirm³and (ii)howthegovernmentontheboardaffectsrisktakingdecisions.Uddin(2014)findsthatgovernmenthassocial,political andeconomicobjectivestoretainownershipinthecorporatefirms.Thesocialandpoliticalobjectivesarerelatedtothe deliveryofemployment,socialservices,andpublicutilities;hencegovernmentnormallyretainsthecontrollingownership inthestrategicallyimportantfirms(Obadan,2008;Mattlin,2009;Boubakrietal.,2009).Theeconomicobjectivesinclude(i) earningadditionalgovernmentrevenuefromthecorporatetaxesanddividendincomesand(ii)helpingthedevelopment ofthecapital market(Boutchkova andMegginson,2000;De LaTorreetal.,2007;PerottiandOijen, 2001).Therefore, thegovernmenthasreasonstoinfluencethecorporaterisktakingdecisionstoachieveitssocial,political,andeconomic objectives.

However,allthegovernmentobjectivesdonotgetthesamepriorityinthegivencircumstancesofacountry.Ifthegov- ernmentprovideshighimportancetothesocialandpoliticalobjectivesinordertomaximizesocialstabilityandemployment (whichhelpsensurethepoliticaltenureofthegovernment),thefirmswithgovernmentownershippursuelessriskyinvest- mentstoreducetheuncertaintyofearnings(Boubakrietal.,2013a;VickersandYarrow,1991).Itislikelythatsuchfirms maystandagainstthewagesandcostcutsoremployeelayoffstosatisfythedesireofthegovernment.Inaddition,the directorsandmanagersnominatedbythegovernmentaremostlyselectedfromthecivilbureaucratswhoaretrainedto servethepoliticalinterestsofthegovernment.Hence,intheabsenceofaneffectivemonitoringsystem,thegovernment appointeddirectors/managerspressurethefirmsnottoengageinriskyinvestmentsifthesocialandpoliticalobjectivesof thegovernmentareaffected.Therefore,ceterisparibus,Icansaythatgovernmentparticipationinthefirmownershipleads tolesscorporaterisktaking.

Theabovepropositionismoreappropriateinthosecountrieswherethepoliticaltenureofthegovernmentisunstable, institutionsaretooweaktomaintainchecksandbalancesintheeconomy,corruptioniswidespread,governmentseeksrent fromthecorporatefirms,andborrowingcostishigh(Boubakrietal.,2013b;Stulz,2005;Qietal.,2010).Thisisbecause thegovernmentsofthesetypesofcountriestypicallytrytomaximizesocialstabilityandemployment(Fogeletal.,2008), atleastfortheshortterm,asthishelpsthemmaintainthetenureofpoliticalpower.Inthisregard,Ifurtheranalyzethat thesocialandpoliticalobjectivesofthegovernmentconflictwiththeeconomicobjectivesintheshortterm,butnotinthe longterm.Ifthefirmscanimplementriskyinvestmentssuccessfully,thegovernmentreceivesmoretaxes,dividends,and capitalgainsinthelongerterm.Thereby,aneconomicallystronggovernmentcanprovideadditionalsocialservicesand employmenttoitscitizensinamoresustainablemanner.Hence,mypropositionofanegativeeffectofthegovernment ownershiponcorporaterisktakingisnotageneralphenomenonunderallcircumstances.Theotherliteratureshowsthat firmsindeedbenefitfromtheirpoliticallinkagewiththegovernmentinmanyways:thepoliticallyconnectedfirmsreceive financialsupportfromthebanksandfinancialinstitutionsonliberalterms,enjoyreducedtaxbenefits,obtaingovernment supportincrises,andhavetheopportunitytoacquiremoremarketshares(Faccioetal.,2006;Faccio,2010;Khwajaand Mian,2005).Therefore,theownershiplinkagewiththegovernmentencouragesafirmtotakeupriskyinvestments,because governmentbeinganownerofthefirmendorsesandshieldssuchriskyinvestments.Hence,thepoliticallylinkedfirms havingagovernmentownershiparevaluedhighlyinthefinancialmarket(Goldmanetal.,2009;LiaoandYoung,2012), despitetheirlowearningquality(Chaneyetal.,2011andUddinetal.,2014).Therefore,ceterisparibus,Icanalsosaythat governmentparticipationinownershiphelpsafirmtotakemorerisk.

Therefore,thereviewoftheaboveliteraturesuggestseitheranegativeorapositiveeffectofgovernmentshareownership oncorporaterisktaking,subjecttohowthegovernmentpursuesitssocial,political,andeconomicobjectivesandcommitsto supportthefirm.Giventhisknowledge,Inowanalyzethebehavioroftherelationshipbetweenthegovernmentownership andcorporaterisktakingbasedonthetheoryofprincipal–principalconflictthatemergesbetweenthecontrollingand minorityshareholders(Dharwadkaretal.,2000;Youngetal.,2008;Chang,2003;Claessensetal.,2002;Thomsenand Pedersen,2000).Ifthegovernmenttransfersthemajorityownershipofafirmtotheprivateshareholders,conflictsarise betweenthegovernment(minorityowner)andtheprivateshareholders(majorityowner)duetothedivergenceoftheir interestsinthefirm(Gilletteetal.,2003).Thisisbecausetheinterestsofmajorityshareholdersmaynotbealignedwith theinterestsoftheminorityownerwhohaspoliticalpowertointerveneincorporatedecisions.Thepoliticalmotivationof governmentistomaintainsocialstabilityandemploymentafterthetransferofthemajorityfirmownershiptotheprivate shareholders,whoaremoreinterestedinthefirm’sperformance,survival,and growth(insteadofservingthepolitical interests)thatrequiremorerisktaking.Inreality,however,theprivateshareholdersoftensuccumbtothepoliticalpressure ofthegovernment,whichisalsoafirmowner.Iftheprivateshareholdersandgovernmentareinastateofdisharmony,the firmrisksnotreceivingthegovernmentsupporttogainmarketpower,lowcostfinance,andmonitoringservicesthatare importanttoachievefastergrowth(Uddinetal.,2014;AngandDing,2006;AljifriandMoustafa,2007).

Thisprincipal–principalconflictisexacerbatedwhenthegovernmentbecomestheminorityshareholder.Thisisbecause theminorityshareholder(thegovernment)exertspoliticalpressure⁴onthemajorityshareholderstoachievegovernment objectives.Inanenvironmentofhighconflictbetweentheminorityandmajorityshareholders,thefirmwillnotundertake

3Thisisirrelevantforthestate-ownedenterpriseswith100%governmentownership.

4Governmentmaintainsagriponthefirmdirectlybymaintainingagoldenshare(ifany)thatprovidesaspecialvotingrighttonegatethemajority decision,andindirectlythroughthepoliticallyconnectedandgovernmentappointeddirectorsofthefirm(ShleiferandVishny,1994;Boubakrietal.,2008).

Table1

Descriptionofsamplesover2004–2013period.

Industry All Non-GLC GLC Rangeofgovernment

shareownership%

Numberof firms

Summarystatisticsofgovernment shareownership%inGLCs(N=55) PanelA:Distributionindustryclassifications PanelB:DistributionofGLCsacrossdifferentlevelsofgovernmentshare

ownershipsandtheirsummarystatistics

Banks 24 7 17 02≤%≤10 8(14.55%) Mean 32.60

Insurance 27 20 7 11≤%≤20 13(23.64%) Median 27.00

Investments 6 3 3 21≤%≤30 11(20.00%) StdDev 20.74

RealEstate 10 2 8 31≤%≤40 4(7.27%) Mode 30.00

Transportation 5 2 3 41≤%≤50 4(7.27%) Minimum 3.00

Manufacturing 27 14 13 51≤%≤60 11(20%) Maximum 80.00

Services 9 5 4 61≤%≤70 2(3.64%) Skewness 0.50

Total 108 53 55 71≤%≤100 2(3.64%) Kurtosis −0.78

Market Allfirms Non-GLCs GLCs Items Allfirms Non-GLCs GLCs

PanelC:Distributionbymarketlistings PanelD:Basiccharacteristicsoffirms

DFM 45 27 18 Assets 15,071mill 4917mill 24,856mill

ADX 63 26 37 Revenues 1626mill 853mill 2370mill

Total 108 53 55 EBIT 406mill 153mill 650mill

Leverage 46% 43% 49%

GLCmeansgovernmentlinkedcompanies.AfirmisclassifiedasGLCifgovernmentholdsaminimumof2%shareownership.DFMmeansDubaiFinancial MarketandADXisAbuDhabiExchange.TheAssets,RevenuesandEBITinPanelDareaveragevaluesinAED(USD1=AED3.67)over2004–2013.The leverageismeasuredbyaveragedebttoassetratioofsamplefirmsover2004–2013.

ariskyinvestment⁵thatincreasesearningsuncertainty,affectingthecashflowandfirmvaluation.Thepoliticalpressure ontheprivateshareholdersbecomeslessimportantifgovernmentmaintainscontrolofthefirmbyholdingthemajority ownership;thenthegovernmentmajorityfirmscanundertakeriskyinvestmentsiftheyareimportantforthecountry.⁶ Basedontheaboveanalyses,IarguethatcorporaterisktakingisnotaffectedduetotheGLCidentityofthefirmperse,but becauseoftheriseofprincipal–principalconflicts(PPC)aftertransferofmajoritysharestotheprivateowners.Sincethelevel ofconflictsincreasesifthemajorityownershipgoestotheprivateshareholdersbutdiminishesifthegovernmentmaintains themajorityownership(ornoownership)inthefirm,itisexpectedthatgovernmentshareownershiphasanegativeeffect (orpositiveeffect)onthecorporaterisktakingwhenthegovernmentistheminority(ormajority)ownerofthefirm.Hence thetestablePPChypothesisisstatedasfollows:

HA. TherelationshipbetweenthegovernmentshareownershipandcorporaterisktakingwilldisplayanonlinearUshaped pattern,allelseequal.

3. Sampledescription

Atotalof134companieswerelistedontheDFMandADXasofDecember2013.However,thesampleincludes108firms (81%ofalllistedfirms),forwhichrequireddataoverthe10yearsfrom2004to2013areavailableindifferentelectronic databases.IcollectedtheaccountingdatafromtheOSIRISdatabaseoftheBureauVanDijkCompanyandtheownershipdata andotherinformationfromdifferentsourcessuchasDFM,ADX,EmiratesSecurities&CommodityAuthority(ESCA),Zyawa database,andcompanyreports.WhileselectingthesampleIensuredthataminimumoffourconsecutiveyears’earning datawereavailable,sothatinactivefirms’datawerenotusedintheempiricaltests.Asawhole,thesampleadequately representstheUAEcapitalmarket,asitcovers81%ofalllistedfirms.Thesizeofthesampleisadequateforasinglecountry study,and10years’dataaresufficientforanyreasonableempiricaltest.DFMandADXwereestablishedin2000;hencethe sampleperiodfrom2004to2013islongenoughtoprovideaclearideaconcerningtherisktakingbehavioroflistedfirms inthismarket.Table1reportsthedistributionanddescriptivestatisticsofthesamplefirms.

PanelAofTable1showsthatthe108samplesaredistributedacrossdifferentindustriesclassifiedbyESCA.Itshows that54firms(50%)belongtotwoindustries,InsuranceandManufacturing,while24firms(22%)areclassifiedasbanks.

Therefore,thesethreeindustriesdominatetheUAEcapitalmarket.Inaddition,10RealEstatefirmsconstituteabout9%of thesample.Ofthe108firms,thegovernmenthasshareownershipin55(51%)thatareclassifiedasGovernmentLinked Companies(GLC).Atotalof30GLCs(60%)belongtotheBankandManufacturingsectors.Thebreakdownshowsthat17

5 Themajorcorporateinvestmentdecisionsneedaminimumagreementbetweentheconflictingownersrepresentingtheboardofdirectors.Itislikely thatthemajoritydirectors,underpressure,willconcedetothegovernmentdesiretonottakeuptheriskyinvestmentthatincreasesearninguncertainty.

Thisisbecausetheriseofearninguncertaintyrequireswageandcostcutsandemployeelayoffsthatdestabilizethesocialorderandgovernmenttenure.

6 Government-ownedfirmstaketheriskofinvestmentininfrastructureprojectsduringtheearlystagesofeconomicdevelopmentwhentheprivate entrepreneursarenotyetcapableoftakinguptheseimportantbuthighlyriskyprojects.Thesefirmsaredivestedgraduallyovertimeiftheprivate entrepreneursarereadytotakeoverandmanagethemmoreefficiently.However,themajoritygovernmentownershipismaintainedinthefirmsthatare strategicallyimportantand/ornotappropriatetogooutoffullcontrolofthegovernment.SeeUddin(2014)formorediscussion.

of24banks(71%),8of10RealEstatefirms(80%),and13of27Manufacturingfirms(48%)areGLCs.PanelBreportsthat averagegovernmentownershipinGLCsisabout32.60%,⁷withastandarddeviationof20.74%.Thedistributiondepictsthat governmentholdsmorethan50%sharesin15(27%)GLCsandlessthan30%sharesin32(58%)GLCs.PanelCreportsthat atotalof63(58%)firmsarelistedonADX,while45(42%)belongtoDFM.Ofthe55GLCs,37(67%)areADXfirmsand18 (33%)fromDFM.PanelDreportsthattheGLCsaresignificantlylargerthanthenon-GLCswithrespecttototalassets(5times larger),revenues(3times),andoperatingearnings(4times).ItisalsofoundthatGLCsaremoreleveragedthannon-GLCs.

Asawhole,governmentownershipiswidespreadinthebanking,realestate,andmanufacturingsectors;moreprevalentin ADXfirms;andfoundmostlyinthelargefirms.Theownershippercentagesarespreadwidelyacrossthedefinedrangesbut concentratedontheleftofthemeanvalue.

4. Testdesignandvariables

IfirstexaminewhethertheGLCidentityofafirmhasaneffectonitscorporaterisktaking.ThenItestwhetherminority andmajoritygovernmentshareownershiphavedifferenteffectsontherisktakingthatfollowsanexaminationofthe behavioralpatternoftherelationshipbetweenthegovernmentownershipandcorporaterisktaking.Last,Iimplement anumberofrobustnessteststhataddresstheendogeneityissue,lageffect,andrestrictsample.Iduplicatethetestsby usingthecross-sectionalandpaneldatatoconfirmtheconsistencyofresults.Severalempiricalmodelsareestimatedusing alternativerisk-takingandgovernmentownershipvariablesthatareelaboratedoninAppendixandsummarizedbelow.

4.1. Risk-takingvariables

Iconstructfouralternativerisk-takingvariablesfollowingpriorstudies(Faccioetal.,2011;Johnetal.,2008;Boubakri etal.,2013a,2013b;HilaryandHui,2009;Uddin,2014)andcommonknowledge.Thecrosssectionaltestsusethefirm’s high-lowearningspread(SPD1)andearningvolatility(VOL1)overa10-yearperiodastheriskproxies.However,thepanel dataregressionsusethesquareddeviation(DEV1)ofafirm’searningsinyeartfromitssampleperiodmean,aswellasthe overlappingperiods’earningvolatilities(VOL^OL1)astheriskproxies.Inthesefourrisktakingvariables,earningisdetermined bythepercentageofreturnonassets(ROA)thatiscalculatedastheratioofearningsbeforetaxes(EBIT)tototalassetstimes 100.Theriskmeasuresareadjustedfortheindustryandmarketeffectstogenerateadjustedrisktakingvariables,whichare usedintheanalyses.TheadjustedriskmeasuresareidentifiedasSPD2,VOL2,DEV2andVOL^OL2.Thesummarydescriptive statisticsofallvariablesarereportedinTable2.I,inwhichPanelAshowsthatthemeansofSPD1,VOL1,DEV1andVOL^OL1are 19.30,6.38,62.73,and4.45,respectively.However,themeansofSPD2,VOL2,DEV2andVOL^OL2are18.03,5.76,44.75,and 4.54,respectively.Thestandarddeviationandminimumandmaximumvaluesofallriskmeasuresdepictalargevariation.

Therefore,dataarewinsorizedonbothsidestoaddressoutlierproblemsinregressionanalyses.

4.2. Governmentownershipvariables

AdummyvariableiscreatedtoexaminewhethertheGLCidentityofafirmhasaneffectonitscorporaterisktaking.

Therefore,afirmisidentifiedasGLC=1ifgovernmentownershipismorethanorequalto2%ofthetotaloutstandingshares,⁸ otherwise0.Fortestingiftheminorityandmajoritygovernmentownershipaffecttherisktakingdifferentlyduetothechange inthefirmcontrol,thesampleisclassifiedintothreegroups:(i)non-GLC(thefirmshavingnogovernmentownership),(ii) GLCwithgovernmentbeingthenon-largestshareholder,and(iii)GLCwithgovernmentbeingthelargestowner.Taking thenon-GLCasthebasegroup,twodummyvariablesareconstructed:GLC^Nonlargest=1ifgovernmentisnotthelargest shareholder,otherwise0;whileGLC^Largest=1ifgovernmentisthelargestshareholder,otherwise0.ItisnotedthatIdonot useanarbitrarycut-offtodeterminetheminorityormajorityshareholder;instead,Iidentifywhoisthelargestshareholder.

Thisisbecausepriorstudiesfoundthatthelargestshareholderisabletomaintainaneffectivecontrolofthefirmsincethe ownershipstructureofamarketlistedcompanyisusuallydiffused(Chenetal.,2008;RousseauandXiao,2008).Nonetheless, anarbitrarycut-offofabove50%ownershipisappliedfortestingrobustness.Additionally,thegovernmentminorityand majorityeffectsarealsotestedbasedontheGLCsonly(restrictedsample).Next,Itrackthepercentageofgovernment ownership(GOVOWN)ineachfirmattheendofeachyearandusethedatainthepanelregressionsthatdeterminethepattern ofrelationshipbetweenthegovernmentownershipandrisktaking.Theaveragepercentageofgovernmentownershipin eachfirmisalsocomputedforuseinthecross-sectionalregressions.Last,thesquaredpercentageofgovernmentshare (GOVOWN²)isincludedintheregressionstodetermineiftherelationshipbetweengovernmentownershipandrisktaking displaysaU-shapedpattern,ashypothesized.MoredetailsofthegovernmentownershipvariablesaregiveninAppendix (PanelB).ThestatisticsinPanelBofTable2showsthatgovernmentmaintainsanownershipin51%firms,withamajority

7Thisishigherthantheinternationalaverage(28.4%)ofgovernmentownershipinprivatizedfirmsasreportedbyBoubakrietal.(2013a).

8Firmownershipisanimportantchanneloflinkagethroughwhichgovernmentacquiresvotingrightsandcannominateboardmembers.IntheUAE, thepublicfirmsdiscloseownershipinformationiftheholdingismorethan2%oftotalshares.Itisnormallyunderstoodthatanyindividual,group,entity, orinstitutionshowsactiveinterestinafirmbyholdingaminimum2%oftheoutstandingshares.

Table2

Summaryofdescriptivestatisticsforregressionvariables.

Variables Mean Median StdDev Min Max Variables Mean Median StdDev Min Max

PanelA:Riskvariables PanelB:Governmentownershipvariables

SPD1 19.30 14.46 17.03 0.40 85.77 GLC 0.51 1.00 0.50 0.00 1.00

SPD2 18.03 14.99 13.39 0.37 61.23 GLC^Minor 0.31 0.00 0.46 0.00 1.00

VOL1 6.38 5.12 5.45 0.20 28.00 GLC^Major 0.20 0.00 0.41 0.00 1.00

VOL2 5.76 5.16 4.15 0.26 20.05 GOVOWN 0.17 0.04 0.22 0.00 0.80

DEV1 62.73 7.94 234.02 0.00 4759.1 GOVOWN² 0.08 0.01 0.14 0.00 0.64

DEV2 44.75 7.50 136.90 0.00 2071.8

VOL^OL1 4.45 2.52 5.30 0.00 36.91

VOL^OL2 4.54 3.55 4.20 0.05 26.95

Variables Mean Median StdDev Min Max Variable Mean Median StdDev Min Max

PanelC:Controlvariables PanelD:Instrumentalvariabletopredictgovernmentownership

LEVER 0.46 0.44 0.25 0.02 0.9 STRATEGIC 0.38 0.00 0.49 0.00 1.00

SIZE 3.38 3.28 0.85 1.27 5.43

FOREIGN 0.10 0.03 0.16 0.00 0.67

GROWTH 0.42 0.19 1.03 −0.11 9.26

MSHARE 0.06 0.02 0.12 0.01 0.71

AGE 17.86 22.00 12.53 1.00 41.00

MARKET 0.42 0.00 0.50 0.00 1.00

Thistablereportssummaryofdescriptivestatisticsforregressionvariablesbasedonthefullsampledataset(10years’datafor108firms),whichincludes boththegovernmentlinkedandnon-governmentlinkedcompanies(GLCsandnon-GLCs).Ofthevariableacronyms,SPDmeansspreadbetweenthehighest andlowestROAsoversampleperiod.VOLisvolatilityofROAoversampleperiod.DEVissquareddeviationofROAofafirmfromitssampleperiodmean, VOL^OLisvolatilityofROAoverafour-yearoverlappingperiod.Theattachednumbers1and2indicaterespectivelyunadjustedandadjustedforindustryand market.GLCisthefirmidentificationasgovernmentlinkedcompany,GLC^Minorisafirminwhichgovernmentisnotthelargestshareholder,GLC^Majorisafirm inwhichgovernmentisthelargestshareholder.GOVOWNispercentageofsharesheldbygovernment.GOVOWN²issquaredpercentageofgovernment share.LEVERisleverageasdebttoassetratio.SIZEisnaturallogarithmoftotalassets.FOREIGNispercentageoftotalsharesheldbyforeigninvestors.

GROWTHisannualsalesgrowth.MSHAREismarketshareratiowithinindustry.AGEisnumberofyearssinceincorporationoffirm.MARKETmeansstock market.STRATEGICmeansclassificationoffirmifitbelongstostrategicallyimportantindustry.Statisticsofsixdummiesforindustriesandninedummies foryearsarenotreportedtosavespace.MoredetailsabouttheseregressionvariablesareavailableinAppendix.

sharein20%firms.Theaveragegovernmentownershiplevelinallfirms(GLCsandnon-GLCscombined)is17percent,while thatintheGLCsonlyis32.60%,asreportedearlierinPanelBofTable1.

4.3. Controlvariables

Iselectanumberofcontrolvariablesbasedontheliterature(Boubakrietal.,2013a;Faccioetal.,2011;Johnetal.,2008;

Corones,1993).Amongthecontrolvariables,theratiooftotaldebttoassets(LEVER)capturestheearningfluctuationsdue tofinancialrisk.Thesizeoffirm(SIZE)measuredbythenaturallogoftotalassetscapturesthefirmsizeeffect.Foreign participationinownershipiswelcomedtoimprovetheperformanceoffirmasitinfusesnewmanagementknow-how, businessstrategy,andproductiontechnologythathelpreduceproductioncostsandotherexpenses(Frydmanetal.,1999).

Thisimpliesthattheforeignownershipparticipationmayinfluencethevariabilityofearnings;hencethepercentageof foreignownership(FOWN)isincludedasacontrolvariable.Thesalesgrowthusuallyindicatesthefirm’sabilitytoexpand businessactivitiesthat involvetakingmorerisks.Therefore,salesgrowth(GROWTH)capturestheinfluenceofgrowth opportunitiesonrisktaking.Firmsusuallytrytogainmarketpowerintheindustrybyincreasingtheirmarketsharethrough undertakingriskyinvestments(Corones,1993).Hence,themarketshare(MSHARE)isincludedasacontrolvariable.Anew firm,beingthelateentrantinthemarket,facesmorechallengetogainadditionalmarketshare;therefore,ayoungfirmhas moreentrepreneurialspritandmotivationtotakehighrisks(Kacperczyk,2012).Therefore,ageofthefirm(AGE)captures thenewfirmeffectontherisktaking.Sincethefirmsarelistedontwodifferentstockmarketsandbelongtodifferent industries,MARKETandINDdummiesareaddedtotheregressionmodelsthatcapturetheunknownmarketandindustry effects.Finally,ninedummyvariablesareincludedinthemodelstocaptureunknowntime(year)effectoncorporaterisk taking.ThedescriptivestatisticsofthesecontrolvariablesarefoundaboveinPanelCofTable2,whiletheirdefinitionsand constructionmethodsareelaboratedinAppendix(PanelC).Tomitigatetheoutlierproblems,thedataofcontrolvariables arealsowinsorizedonboththesidesata1%level.

4.4. Instrumentalvariable

Thereisaconcernthatgovernmentownershipinafirmmaynotbeexogenous,becausethegovernmentmaintainsfirm ownershiptoachieveitssocio-politicalandeconomicgoals.Ifrisktakingdecisionsaffectfirmperformanceandgrowththe government,asanowner,isalsoaffected.Hence,theregressionresultsmaybebiasedbecauseofthelikelyreversecausality problem.Inaddition,someunobservedfactorsmayalsodeterminethegovernmentshareownership.Therefore,Iattemptto addressthelikelyendogeneityproblembyidentifyinganinstrumentalvariablethatpredictsthegovernmentownershipin

thefirmsandusingitinthetwo-stageregressiontests.Uddin(2014)findsthattheprobabilityofgovernmentshareholding inthemarketlistedfirmsisdeterminedbythestrategicimportanceoftheindustry,theprofitearningabilityofthefirm, andthemarketvaluationoffirm.However,inthisstudy,Iselectthestrategicimportanceofindustry(STRATEGIC)asthe instrumenttoestimategovernmentownershipinthefirmsbecausetheeconomicandpoliticalcircumstancesdeterminethe strategicimportanceoftheindustries.IfindthatSTRATEGIChasasignificantrelationshipwiththegovernmentownership butaninsignificantrelationshipwiththerisktakingvariables.⁹ThedetailsoftheSTRATEGICvariablearegiveninAppendix (PanelD),whilethedescriptivestatisticsreportedinPanelDofTable2aboveshowthatapproximately38%firmsintheUAE belongtotheindustriesthatarestrategicallyimportantforthecountry.

5. Empiricalfindings

ThelogicalargumentofthispaperisthatthefirmidentityperseasGLCornon-GLCisnotthemainreasonforhaving aneffectonthecorporaterisktaking,butthegovernmentownershipaffectstherisktakingdecisionssincethegovernment andtheprivateownersengageinconflictwhenthemajoritysharesgooutofthegovernmentcontrol.Hence,Iimplement theempiricaltestsalongthis lineoflogicalargument.Inthis section,Ifirstanalyzetheresultsrelatedtotheeffectof firmidentifyoncorporaterisktaking,andthenIdiscussthefindingsontheeffectofthelevelofgovernmentownership participationontherisktakingbythefirmandthepatternoftherelationshipbetweenthegovernmentshareholdingandthe corporaterisktaking.Next,Iexaminewhetherthegovernmentownershiphasanylaggedeffectonrisktaking,inaddition tothecontemporaneouseffect.Thesetestsareexecutedwithandwithoutendogeneitycorrection.Finally,Iexaminethe robustnessoftheresultswithrespecttothedifferentgovernmentownershipclassificationsandrestrictsamplesoftheGLCs only.

5.1. GLCidentity

IimplementtwoteststodeterminetheeffectoftheGLCidentityofthefirmperseoncorporaterisktaking.TEST-A usesthecrosssectionaldataandTEST-Busesthepaneldatawiththedimensionsoffirmandyear.Anumberofalternative risktakingvariablesareusedasthedependentvariablestoestimatetheeffectoftheGLCidentityofthefirm.TEST-Auses SPD1,VOL1,SPD2,andVOL2asthedependentvariablesinthecross-sectionalregressions,inwhichSPD1andVOL1arethe unadjustedmeasuresofrisktaking,whileSPD2andVOL2aretheindustryandmarketadjustedmeasuresofrisk.Similarly, TEST-BusesDEV1,VOL^OL1,DEV2andVOL^OL2asthedependentvariablesinthepanelregressions.Ofthese,DEV1andVOL^OL1 aretheunadjustedrisktakingvariableswhileDEV2andVOL^OL2aretheindustryandmarketadjustedriskvariables.Inthe bothcross-sectionalandpaneldataregressions,GLCisassignedasthedummy(1,0)variable,whereGLC=1ifthefirmis identifiedasthegovernmentlinkedcompany,otherwise0.AnumberofcontrolvariablessuchasLEVER,SIZE,FOREIGN, GROWTH,MSHARE,andAGEareincludedinthebothcross-sectionalandpanelregressions.Additionally,IND,MARKETand YEAR(forpanelregressionsonly)areincludedtocapturethefixedeffectonthedependentvariables.

InTable3,thecross-sectionalregressionsofTEST-AshowthatGLChasaninsignificantnegativeeffectonalloftherisk takingvariablessuchasSPD1,VOL1,SPD2,andVOL2.However,thepanelregressionsofTEST-Bshowthatthetwomodels thatuseDEV1andVOL^OL1asthedependentvariablesfindaninsignificantpositiveeffectofGLC;whilethoseuseDEV2and VOL^OL2asthedependentvariablesfindaninsignificantnegativeeffectofGLC.Therefore,settingasidetheresultsrelatedto theunadjustedriskmeasures,alloftheadjustedriskvariablesshowaninsignificantnegativeeffectoftheGLCidentityof thefirm.ThenegativeGLCcoefficientsapparentlyindicatethatthegovernmentownershippersemaydiscouragethefirm fromtakingupriskyprojects,butIcannotconfirmitbasedonthetestsofsignificance.Aswhole,theUAEevidenceshows thattheGLCidentityofthefirmpersedoesnotsignificantlyaffectthecorporaterisktaking.

Lookingatthecontrolvariables,IfindthatLEVERissignificantonlyinthetwocross-sectionalregressionsofTEST-Athat usetheSPD1andVOL1asthedependentvariables.Allofthecross-sectionalandpanelregressionsidentifythatSIZEhas nosignificantassociationwithcorporaterisktaking.IalsofindthatFOREIGNhasasignificantlynegativerelationshipwith corporaterisktaking,asshownbyalltheriskvariablesexceptVOL^OL1andVOL^OL2,whichareusedinthepanelregressions ofTEST-B.Thisresultisnotconsistentwiththecross-countryevidenceofBoubakrietal.(2013a).Theyfindthattheforeign ownershiphasasignificantlypositiverelationshipwiththecorporaterisktaking.Therefore,myfindingofthenegative relationshipbetweentheforeignownershipandrisktakingsuggeststhattheforeigninvestorsavoidrisktakingintheUAE, whichmayconcernboththeeconomicpolicymakersandforeigninvestors.Thisissueisimportantbecausepriorstudies foundthatforeigninvestmentnormallyimprovesthelevelofcorporategovernanceandtherebytherisktaking,sincea bettergovernanceenvironmentpreventsthestakeholdersfrompursuingtheirowninterestsinthefirm(Stulz,1999;John etal.,2008).However,theUAEcaselooksdifferent.Hence,theUAEpolicymakerscanreviewthecorporategovernancerules andregulationstoironouttheinconsistenciesthatseemtohinderforeigninvestmentsinthelocalfirms.

9Twoothervariables(theabilitytoearnprofitandfirmvaluation)ofUddin(2014)determinethegovernmentshareownershipintheUAEfirms,but theyhaveasignificantrelationshipwiththerisktaking.Therefore,thesecannotbeusedassuitableinstruments.Nonetheless,thestrategicimportanceof theindustryadequatelyservesmypurposetoestimatetheexogenousvariationofthegovernmentownershipinthefirms.