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Journal of Management and Governance

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16.06.2018

Independent minority directors and firm value in a principal–principal agency setting: evidence from Italy

Erschienen in: Journal of Management and Governance | Ausgabe 1/2019

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Abstract

Following the agency theory, this paper contributes to the literature on board independence as a mechanism to mitigate agency costs by investigating the impact of independent minority directors on firm value in a principal–principal setting. Independent minority directors might alleviate agency costs associated to the risk of self-dealing transactions and, in turn, increase firm value. However, since non-controlling shareholders are also self-interested, particularly for firms characterized by strong uncertainty about future financial results and high information asymmetry, independent minority directors might negatively impact firm value by creating frictions within the board, increasing the risks of potential hold-ups by minority shareholders and limiting the ex-ante incentives of the block-holder to undertake profitable idiosyncratic investments. By examining a sample of Italian listed companies, we find some evidence about a positive relationship between the proportion of independent minority directors and firm value. Although weaker, a positive relationship between the proportion of independent minority directors and firm value is also found for firms characterized by high information asymmetry and—therefore—exposed to the risk of opportunistic actions by minority shareholders against the dominant shareholder. Our results shed new light on the relationship between board composition and firm value in a concentrated ownership setting, revealing the role played by independent minority directors in mitigating agency costs.

Vorheriger Artikel CEO career horizons and when to go public: the relationship between risk-taking, speed and CEO power

Nächster Artikel Balancing control and delegation: the moderating influence of managerial discretion on performance effects of board monitoring and CEO human capital

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Commonly, Private Benefits of Control (PBC) are divided into two types: the first type is ‘mismanagement’ (or distortionary PBC), including shirking, reduce commitment, pursuing acquisition just to increase firm size (empire-building) or to diversify firm’s businesses; the second type is ‘takings’ (or diversionary PBC), in which the corporate controller diverts to herself pecuniary benefits by consuming excessive pay or by tunnelling through related party transactions (cash flow or assets tunnelling) (Goshen and Hamdani 2016). Considering that ‘distortionary’ PBC dominate in case of widely-held companies, while agency costs mainly arise from ‘diversionary’ PBC in the typical controlling-shareholder firms (Enriques and Volpin 2007; Bebchuk and Hamdani 2009), in our paper we refer to ‘diversionary’ PBC to describe the opportunistic behaviour by the corporate controller in a principal-principal setting.

Following an agency framework, this paper focuses its attention on the board’s monitoring role and, therefore, analyzes the impact of independent minority directors on firm value. In fact, in an agency perspective, executive directors—although nominated by minority shareholders—are expected to reduce board monitoring.

According to Williamson (1985) “idiosyncratic investments are non-fungible investments that uniquely support the buyer-supplier relationship”. Anderson and Weitz (1992) define idiosyncratic investments as “investments to a specific relationship which are difficult to switch to another relationship”.

Indeed, the above-mentioned relationship between minority directors and stricter RPTs internal codes or remuneration policies—documented by Bianchi et al. (2014) and Belcredi et al. (2014)—might also reduce the probability of efficient intra-group transactions and negatively affect the effectiveness of remuneration contracts designed to align management’s interests with those of shareholders, with a negative impact on firm value. In this regard, Tiscini and Raoli (2013) document the use of stock option plans (SOPs) in closely-held firms as an instrument to remunerate the block-holder for its firm-specific investments. Allowing minority shareholders to influence the terms of SOPs through their representatives on board might therefore limit the magnitude of idiosyncratic private benefits extracted by the dominant shareholder for some positive contribution to the firm, in excess of the working activities and financial capital that are already rewarded respectively by wages and profits.

Slate voting was first introduced in Italy by Law 474/1994, which regulated the privatisation of publicly owned enterprises. In 1998 slate voting has been mandated for the election of statutory auditors and it was extended to the election of directors in 2005. However, it became effective in June 2007.

The Italian Consolidated Law of Finance (TUF, Art. 147-ter, par. 3) first required listed companies to specify the minimum participation threshold needed to present a list. This threshold, however, could not exceed the 2.5% of the share capital. Then, a new Consob rule replaced the 2.5% quorum cap with six different thresholds (from 0.5 to 4.5 per cent of share capital, depending on the market capitalisation of the reporting entity).

The CGC defines as independent directors who: (1) have no relevant business relationships with the company, its subsidiaries, its managers, its executive directors and its controlling shareholders; (2) are not owners of such a quantity of shares which can give them the power to control the company and are not part of an agreement with other shareholders which gives them the power to control the company; and (3) are not immediate family members of executive directors of the company or of other persons who are in the situations referred to in points (1) and (2).

In accordance to the TUF, the following persons may not be elected as independent directors: (a) interdicted and banned persons, disqualified persons, bankrupt persons or those persons who have been sentenced to a penalty entailing a ban, even temporary, from public office or the inability to exercise managerial functions; (b) spouses, relatives and the like up to the fourth degree of kinship of the directors of the company, spouses, relatives and the like up to the fourth degree of kinship of the directors of the companies it controls, the companies it is controlled by and those subject to common control; (c) persons who are linked to the company, the companies it controls, the companies it is controlled by and those subject to common control or to directors of the company or persons referred to in paragraph (b) by self-employment or employee relationships or by other relationships of an economic or professional nature that might compromise their independence.

Our model is based on the 3 months’ bid-ask spread.

Changes in traded securities’ values is determined as \(Price\;High/Price\;Low\), where Price High represents higher price and Price Low is the lower one.

See also International Financial Statistics (IFS) reports and data.

For the sake of brevity, the results are not reported here, but are available from the authors.

We do not graphically represent the relationship between BoDInd_C and Tobin’s Q as the coefficient (β₂= 0.12) is not statistically significant.

Endogeneity between independent minority directors and firm value are also mitigated by the results of a binary logistic regression analysis on the determinants of minority slates in our sample firms. In this case, we regress a variable capturing the probability that minority shareholders submit a slate (a dichotomic variable that takes the value of one when minority shareholders submit a slate, and zero otherwise) on a set of financial, corporate governance and market variables (including Tobin’s Q). We find that Tobin’s Q does not significantly affect the probability of minority slates, using both contemporaneous and lagged explanatory variables (for the sake of brevity, results not reported here but available from the authors upon request).

We also develop an effect size analysis to estimate the strength of our estimations. We firstly use the Cohen’s f^² index. Then, we compute the ‘eta squared’ coefficients to measure the effect sizes of our regressors. Cohen’s f^² index equals 0.4573. This value allows us to assert that our regressors explain a moderate to large portion (from 0.39 to 0.59) of Tobin’s Q variance. An analysis of the ‘eta squared’ shows a small effect (lower than 0.02) played by the proportion of minority independent directors (BoD_IndM) in explaining Tobin’s Q variance. A small effect is also detected by observing the ‘eta squared’ of the interaction variable BoD_IndM * B_A_Dummy. Indeed, the ‘eta squared’ analysis shows a weak role played by most of the examined corporate governance variables, except for firm size (LnSales), accounting measure of profitability (ROA), indebtedness (Leverage) and the macroeconomic variable Crisis. It is however worthy to notice that the effect size associated to the proportion of independent minority directors is much higher than that concerning the independent directors nominated by the controlling shareholders; when mediated by the bid-ask spread, the independent minority directors and the independent majority directors exercise a similar effect on Tobin’s Q variance. Then, the adoption of a ‘multiple-winner’ system (a ‘slate-vote-system’ based on quotas) might significantly impact on firm value relatively to the traditional ‘winner-takes-all’ procedure. For the sake of brevity, results are not tabled here, but are available from authors.

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Titel: Independent minority directors and firm value in a principal–principal agency setting: evidence from Italy
Publikationsdatum: 16.06.2018
Erschienen in: Journal of Management and Governance / Ausgabe 1/2019
Print ISSN: 1385-3457
Elektronische ISSN: 1572-963X
DOI: https://doi.org/10.1007/s10997-018-9421-0

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