Insider Ownership and Firm Value: Evidence from Indian Corporate Sector

Author(s): Manoj Pant and Manoranjan Pattanayak

Source: Economic and Political Weekly, Vol. 42, No. 16 (Apr. 21-27, 2007), pp. 1459-1467
Published by: Economic and Political Weekly
Stable URL: https://www.jstor.org/stable/4419499
Accessed: 04-02-2020 19:48 UTC

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 Insider Ownership and Firm Value
Evidence from Indian Corporate Sector
This paper examines the effect of insider ownership on corporate value in India for the period
of 2000-01 to 2003-04, using 1,833 Bombay Stock Exchange listed firms by investigating the
relationship between insider's equity holding and firm value. While the "convergence of
interest" or "monitoring" hypothesis predicts a positive relationship, the "entrenchment"
hypothesis predicts a negative one. This paper also provides evidence that the relationship
between insider shareholding and firm value is not linear in nature and documents a
significant non-monotonic relationship between the two. Tobin's Q first increases, then declines
and finally rises as ownership by insiders rises. It also confirms that foreign promoter/
collaborator shareholding has a significant positive impact on firm value.

MANOJ PANT, MANORANJAN PATTANAYAK

fter the successful takeover of Arcelor by L N Mittal, the effects operate at different levels of shareholding, thus re-
the Tata group chairman Ratan Tata made a statementsulting in a non-linear relationship between insider ownership
that, "The steel industry is fragmented and considerablylevel and performance. However, the veracity of several predic-
vulnerable. The only safeguard is to increase the founding family'stions can only be empirically examined.
stake over time...the increase in stake is to ensure that manage- In India, ownership structure is highly concentrated in the hands
ment control remains with promoters" (The Economic Times,of family members and their acquaintances. The post-liberalisation
July 7, 2006). The entire Reliance fiasco started with a statementcapital market in India is showing steady progress with a large
by Mukesh Ambani where he admitted that ownership is an issuenumber of small shareholders participating in the equity market.
in Reliance Industries. Finally, the company was split into two When such a fortune is concentrated in the hands of a few people,
groups. While discussing issues on corporate governance, Rahul it draws our immediate attention. The east Asian crisis reminds
Bajaj said, "More than 75 per cent of large listed Indian companies people how a poor governance structure can ruin an economy
are family owned, in which a family has a significant shareholdingwithin no time. The family based governance model failed the
in the company...companies where management has little or no economies of the east Asian countries and created havoc around
stake in the company constitute less than 5 per cent of large,the world [Claessens 2000; Lemmon and Lins 2003]. Therefore,
listed companies. In a company managed by 'owners', there isit is imperative to study the performance of firms in India where
a very strong motivation for management to work for a long- family and kinship ties still dominate business decisions. Against
term share price increase" [Business Standard, July 29, 2005].this backdrop, the current paper measures the performance of
These three unrelated facts have one commonality, that is, the Indian firms where insider ownership stake plays a key explana-
issue of ownership, control rights and shareholder's wealthtory variable. Due to a large shareholding concentration in the
maximisation. hand of families, professional managers have no option but to
Which governance structure is appropriate for an emerging execute the decree of insiders/promoters of the firm. In a majority
economy like India? Do family-run business entities perform of firms, there is no separation of chief executive officers and
better than professional-run firms? Does the widely held firm chair; therefore, family supremacy is more overt than covert. With
command better stock prices than one with ownership concen- a moderately developed capital market, a non-existent market
tration? As the Indian stock market is expanding in terms of for corporate control and weak product market competition, India
volume of trading and market capitalisation, these questions need
presents a unique opportunity and challenge to study the behaviour
to be addressed by regulatory bodies like the Securities and of insiders.
Exchange Board of India (SEBI). Yet, very little work exists onTo outline the organisation of the paper, Section I reviews the
these issues in the Indian context. In this paper, we will look related empirical literature. The major hypotheses of the study
at some of these issues in an econometric framework. are stated in Section II. In Section III, we have explained the
The issue of ownership, control rights and firm value sovariables
far used in the econometric model. The descriptive results
has drawn wide attention from academia in advanced countries. are analysed in Section IV. The empirical model and results are
discussed in Section V and a summary of major findings is
All theoretical and empirical research on the relationship between
equity ownership and performance is influenced by the separationreported in Section VI.
thesis of Berle and Means (1932). However, extant literature
reveals that concentrated holding is widely prevalent around the
world [Holdemess 2005; Claessens et al 2000; Laporta et al
Insider Ownership and Firm Value: Evidence
1998]. The convergence-of-interest or monitoring hypothesis
There are a large number of studies on ownership, governance
predicts a positive relationship between ownership concentration
and firm performance; at the same time the entrenchment hy- structure and firm performance [for a survey see, Shleifer and
Vishny 1997; Classens et al 2002; Holderness 2003]. However,
pothesis proposes a negative one. Some authors argue that both

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 Figure 1 traditional neo-classical framework where institutional mecha-

Firm nisms are suppressed. In the later phase of the 1990s, some Indian
Value scholars have tried to fill this gap by exclusively focusing on
India. Studies by Chhibber and Majumdar( 1998, 1999), Majumdar
and Chhibber (1998), Patibandla (2006), Sarkar and Sarkar (1999,
2000), Khanna and Palepu (1999, 2000, 2004) are the few studies
on the Indian corporate governance system.
Chhibber and Majumdar (1999) study the impact of foreign
shareholding on a firm's profitability and contrast the pre-reform
and post-reform character of such holdings. After controlling for
a variety of firm and environment-specific factors, the study finds
that post-reform foreign ownership holdings have significant
effects on firm profitability. Khanna and Palepu (1999) find that
insider ownership has a positive and significant impact on firm
value while director's holding has no perceptible impact. The most
0 Z1 Z2 Per cent of X descriptive study on Indian corporate governance has been done
Convergence Convergence Insider Share by Sarkar and Sarkar (1999) using micro level data of 1,613 firms
of Interest Entrench- of Interest
ment for the year 1995-96. Director's shareholding shows a non-linear
relation with firm value - i e, it first decreases up to 25 per cent
most of the attention has been given to corporate governance and increases thereafter. In the case of corporate bodies'
problems in developed countries. Here we have attempted toshareholding, beyond 15 per cent Q-ratio shows a positive
bridge this gap by focusing on an emerging economy like India.
association with firm value. For foreign shareholdings, there is
Demsetz (1983) maintains that ownership structure is ana monotonic increase in shareholder value. Sarkar and Sarkar
endogenous outcome of the maximisation process. Therefore, (2005) provide evidence that promoter shareholding has no impact
every change in ownership level is made in order to maximise on firm value in case of low growth firms while it has a positive
shareholder profit. Consequently, the ownership concentrationimpact on firm value for high growth firms.
and the profit rate are unrelated. Demsetz and Lehn (1985) and
Demsetz and Villalonga (2001) in their respective studies find II
ownership concentration and firm performance to be unrelated. Major Hypotheses
Holderness et al (1999) find that ownership has a non-linear
impact on firm performance. Morck, Shleifer and Vishny (1988, The empirical and theoretical literature suggests that the re-
henceforth MSV) attempt to capture the convergence-of-interest lationship between managerial/insider ownership and firm value
and entrenchment effect in a sample of 371 Fortune 500 firms. is non-linear in nature. This non-linearity is ascribed to the
Using a piecewise linear regression function they find a signifi-
convergence of interest and entrenchment hypothesis. When the
cant non-monotonic relationship between board ownership andshareholding of insiders is very low, the entrenchment effect is
firm performance. McConnell and Servaes (1990) examine the
non-operational due to less control over the decision-making
relation between Tobin's Q and ownership structure for a sample process of the firm. However, once they gain controlling authority
1,173 US firms for 1976 and 1,093 firms for 1986. They find in the firm, they can entrench themselves or pursue non-value
strong evidence of a curvilinear relation between insider own- maximising activities. As per the entrenchment hypothesis, more
ership and Q. equity ownership by a manager/insider may lead to lower finan-
Short and Keasey (1999) study the relation between managerial cial performance. But with majority ownership (say, more than
ownership and firm performance from the UK perspective. They 50 per cent), their interest is better aligned with the interests of
find that for both the return on shareholders' equity (RSE) and the firm. They have to bear 50 per cent of the loss of each penny
market value to book value ratio (VAL), the coefficients of forgone. It may be noted that incentive effects operate positively
director shareholding (DIR), DIR2 and DIR3 are positive, nega- at all levels of ownership. Each increment in shareholding induces
tive and positive respectively and all are statistically significant. the manager/insider to perform. However, it is the dominance
Faccio and Lasfer (2000) also document similar findings for high of the entrenchment effect over the incentives effect at a medium
growth firms in UK. Cho (1998) is very critical about the implicit level of ownership that drives the value of the firm downwards.
assumption of exogenous ownership structure in several studies. Considering the above arguments, we test for any non-linearity
He has used a system of equations for insider ownership, in the relationship between insider ownership and market value.
corporate value and investment. His result shows that investment More formally, the hypothesis is stated below:
affects corporate value, which in turn affects the ownership Hypothesis I: Firm performance is a non-monotonic function of
structure but not vice versa. Himmelberg, Hubbard and Palia share ownership by insiders. In other words, firm value first
[HHP 1999] using a fixed effect panel data method to control increases, then decreases and thereafter increases with insider
for unobserved firm level heterogeneity conclude that ownership.
managerial ownership has no statistically significant effect on In a graph (Figure 1), the hypothesis can be described as
firm performance. follows:
There are few studies available on India which are explicitly Foreign promoters/collaborators act as strategic partners for
designed to address the issues of the institutional structure of a domestic corporation when they come up with technological
production. Most of the studies which are undertaken in the expertise. The technological and organisational advantages of
context of India are at the industry level and structured in the foreign firms and their ability to operate internationally bring

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reputational advantages vis-a-vis domestically owned firms. As
foreign firms operate globally, family dominance is less in their
firm. They recruit professionals to look after their overseas affairs.
This brings professionalism into the firm and family dominance
may weaken. In some countries, foreign firms also receive several
fiscal incentives from the host governments. This may translate
into higher market value for the firm. Therefore, we hypothesise
that firms with foreign promoters/collaborators tend to have
higher market value vis-a-vis domestically owned firms.
Hypothesis II: Firms with a foreign promoter/collaborator will
have a higher market value than completely domestically
owned firms.
Ill
Data Base and Explanation of Variables
The sample for the study is drawn from Prowess, a database
developed and maintained by the Centre for Monitoring Indian
Economy (CMIE). Our initial sample consists of 1,833 listed firms
in India. Most of the firms are listed on the Bombay Stock
Exchange (BSE) and National Stock Exchange (NSE) of India. For
each firm we have four years of observations, i e, 2000-01 to
2003-04. Out of a large panel we have eliminated those for whom
(a) sales data, (b) shareholding pattern information, and (c) selected
stock indicators like share prices and market capitalisation are
missing. All together we have 1,833 firms with 7,330 obser-
vations. The sample consists of both large and small firms.
Variables of Interest
The major variables of interest for the present study are th
amount of share ownership by insiders.
INS: The fraction of equity shares held by insiders/promoters
INSSQ and INSCU are the square and cube of insider share
respectively. Promoter share reflects direct insider holding in th
firm. In the Indian context it is the family holding in the firm
FORPRES: A categorical variable FORPRES is generated, whic
is equal to 1 if there is foreign promoter share within promot
share. In our sample, there are 345 firms where a foreign promot
holds a share.
FORS<26 per cent: A categorical variable that is equal to 1 if
foreign promoter share within promoter/insider share is less than
0.26, 0 otherwise.
FORS:>26-51 per cent: A categorical variable that is equal to
1 if foreign promoter share within promoter/insider share is more
than or equal to 0.26 and less than 0.51, 0 otherwise.
FORS:>51 per cent: A categorical variable that is equal to 1
if foreign promoter share within promoter/insider share is more
than or equal to 0.51, 0 otherwise.
INS.SP: Here, Ins.spl to Ins.sp3 are the three spline variables
of insider ownership which are discussed later in the paper.
As we have already stated, the performance of a firm is
determined by a host of factors. In the ownership-performance
model if we do not control for these factors, then the emerging
relationship will be a spurious one. The selection of the control
variable is a tedious one as there are numerous factors which

Explanation of Variables affect firm performance. To make the task simple, we have relied
upon two studies - Cho (1998) and HHP (1999). Besides these,
Perormance measures: In the corporate governance framework, we have considered several other control variables which are
most authors rely on market based performance indicators of the either India specific or significant on theoretical grounds. The
firm (Tobin's Q) to measure performance. Tobin's Q is defined constructed variables are given in Table 1.
as the ratio of the market value of equity, i e, number of shares
times the secondary market price plus preference capital plus the IV
book value of its debt - to the book value of the fixed assets
Descriptive Results
of the firm. This market value exhibits the discounted present
value of its expected future income stream whereas the book Ownership
value Classification and Market Value of Firms
of equity shows the investment in assets by shareholders in the
assets utilised to generate that income stream. Therefore,Wetheview the ownership structure of firms as a way to organise
Q ratio, taking into account the future prospects of theand
firm
run economic activity. We hypothesise that the success and
provides a measure of the management's ability to generate a of any form of ownership organisation depends upon
continuance
certain income stream from an asset base [Short and Keasey
its performance, i e, real or perceived. In Table 2, we present
1999]. It is argued that accounting measures such as return of
the performance of firms when the insider is the majority share-
assets (ROA), return of equity (ROE) and return on sales holder
(ROS) and otherwise. When a shareholder holds more than 50
are noisy as all firms do not follow the same accounting procedure
per cent of the share in a firm, he/she has strategic control over
in emerging economies. the firm. As per the Indian Companies Act 1956; with more than

Table 1: Explanation of Variables

Variables Abbreviation/Model Name Measurement

Sales LN(S) Firm size is measured using natural logarithm of sales revenue for each year.
Leverage LEV Leverage is defined as the ratio of long term debt to total assets.
Age LN(Age) Age is defined as the number of years between the observation year and the firm's
incorporation year.
Operating income Y/S Operating income is a measure of profitability and measured as the ratio of cash
profits to sales.
Capital expenditure I/K This is the capital expenditure or new fixed assets creation in the firm. It is measured
as the ratio of expenditure in purchase of new fixed assets to gross fixe
Research and development intensity R&D/K This is measured as the ratio of R&D expenditure to capital.
Selling intensity ADV/K This is defined as the ratio of advertising and promotional expenditures to capital.
Capital intensity K/S This is defined as the ratio of gross fixed assets to sales.
Liquidity LIQUIDITY Turnover rate is used as a proxy for liquidity. Turnover is measured as the annual
average number of shares traded over total number of shares
BSE 500 BSE 500 A dummy variable is generated to distinguish between BSE-500 firms and others. If
the firm belongs to the BSE 500 list then it is coded as 1, else it is zero

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a 50 per cent ownership stake, an investor can pass an ordinary of the relationship between firm value and insider ownership
resolution which governs among others - adoption of annual allows us to investigate both the convergence of interest and
accounts, matters related to the alteration of the capital structure entrenchment effects according to the level of insider ownership.
of the company, issues related to the appointment of auditors This method enables us to determine the optimal break points
and their remuneration, appointment of directors and their re- within the system, which is not the case in the spline specification.
muneration and issues related to the voluntary winding up of a The primary specification is:
company. Thus, it is useful to examine the performance of firms
Performanceit = a + 3 (ownership)it + yXit + Ot + 6t + Eit
when property rights are fully devolved to insiders vis-a-vis firms
where ownership is widely diffused. Where (ownership)it measures the fraction of the equity of
In our sample there are 3,722 (930 firms) observations where firm i, lying between 0 and 1, which is owned by insiders in
the insider stakes less than 51 per cent and 3,608 observations period t. The control variables Xit are industry specific factors.
(902 firms) where the insider stake is more than or equal to 51 Here, industry specific fixed effects are 6t, time effects 0t and
per cent. In Table 2 (Panel A), we show the performance of firms a random unobserved component Eit. To introduce non-linearites
when insider share is less than 51 per cent and Panel B shows as is confirmed by MSV (1988), McConnell and Servaes (1990,
the performance of firms when insiders' share is more or equal 1995), Kole (1995) and Short and Keasey (1999), we have used
to 51 per cent. There are three kinds of performance parameters the polynomial function of insider ownership such as
- (a) market related or Tobin's Q and its variants like Mktbook, (ownership)2it, (ownership)3it. Therefore, we can expand our
Mbvr, Mtbe, Metba, MVA, (b) accounting ratios like ROA, ROE basic model to:
and earnings per share (EPS), and (c) agency cost measures like
Performanceit = a + P1 (ownership)it + P2 (ownership)2it +
operating expense ratio and asset turnover. The average
33 (ownership)3it + yXit + Ot + 6i + Eit
(median) Q-ratio is 0.69 (0.55) when insider share is less than
51 per cent whereas the respective figures are 0.73 (0.57) when Completing the regression with the notations and control
shareholding increases to 51 per cent. All other market variables explained earlier, the above model can be developed
related indicators exhibit similar results. ROA is 0.03 decimal as follows:
points more when the insider has 51 per cent or more stakesPerformanceit
in = a + P1 (INS)it + 32 (INS)2it + P3 (INS)3it + YlLn(s)it
the firm. Though ROE is higher when insider has less than 51
+ y2Ln(s)2 + Y3(Y/S)it + y4(LEV)it + Y5(LEV)2it + Y6(R&D/K)it
per cent stake in the firm, the difference is not statistically
significant as given in the last column of Table 2. EPS and+ y7(ADV/K)it + Y8(IK)it + y9(K/S)it + Y10Ln(age)it
market value added (MVA) are more for higher insider ownershipY1 I(FORPRES)it + Y12(FORS26- 51 %)it + Y13(FORS > 51%)it
+
firms. In the literature, agency cost is directly measured by
+ y14(BSE500)it + 0t + 6t + Eit
operating expense ratio and asset turnover [Ang, Cole and Lin
2000; Singh and Davidson 2003]. Operating expense will be MSV (1988) use a piecewise linear regression model to study
higher and asset turnover will be low in the presence of high
the non-linear relationship between board ownership and firm
agency costs. When the insider is not the majority shareowner,
performance. Henceforth, it has been widely used in such kind
of studies, including some work on India [Sarkar and Sarkar 2000;
operatingexpense ratio is 1.50 and asset turnover is 0.82. When the
Chhibber and Majumdar 1998]. Here, we can describe the model
insider stake is equal to or more than 51 per cent, operating expense
ratio is less, i e, 1.08 and asset turnover is more, i e, 0.97. As we
can see from the last column, except ROE and MVA, the difference Table 2: Ownership-Performance
in the mean value of all the performance indicators between the Panel-A Panel-B t-Stat of

two ownership categories is statistically significant. Therefore, Insider Ownership Insider Ownership Difference
Share<51 Per Cent Share>51 Per Cent in Mean
as the insiderownership stake increases or property rights devolve Mean Median Mean Median
fully to insiders, the performance of the firm also improves.
Tobin's Q 0.69 0.55 0.73 0.57 -2.49*
Mktbook 0.99 0.97 1.18 1.03 -9.50*
V
Mbvr 0.69 0.31 0.99 0.41 -3.77*
Empirical Specifications and Results Mtbe 4.62 0.71 5.87 1.40 -3.41*
Metba 0.32 0.13 0.39 0.17 -4.32*
In this section our objective is to specify an appropriate func- ROA 0.08 0.08 0.11 0.11 -7.83*
ROE 1.91 0.47 1.82 0.94 0.57
tional form for the relationship between the insider ownership
structure of firms and their value, which will enable us to test Operating expense 1.50 0.89 1.08 0.87 3.35*
Asset turnover 0.82 0.68 0.97 0.87 -8.12*
our hypotheses. According to previous empirical evidence, the EPS 3.88 0.53 6.24 2.02 -1.98*
hypotheses examined here describe the potential non-linear effects MVA 39.37 -2.87 46.63 4.00 -1.33
of insider ownership structure on firm value. Our first hypothesis
NB: The last column shows statist
predicts a cubic relationship between value and ownership
less than 51 per cent insider ow
concentration as a result of joint consideration of incentive insider ownership, * Significant a
alignment and entrenchment effects. of assets - book value of equity
To examine the ownership effect on firm value, we regress assets, Mbvr = (market value of e
the Q-ratio, our measure of profitability, on measures of insider Metba = market value of equity/b
total paid-up equity capital, ROA
ownership share, as well as other variables which should affect
expense = (cost of sales + admin
Tobin's Q. We have used two methods - (a) a cubic (polynomial) turnover = net sales/average total
equation method and (b) the spline method. Each method has no of outstanding shares) - (bo
its own advantages and disadvantages. Adopting a cubic form shares) EPS = profit after tax/no

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 Figure 2: Predicted Tobin's Q and Insider Share moves from alignment to entrenchment and to alignment as their
(Pooled Data Cubic Estimation)
ownership stake in the firm increases. Even if each ownership
1.2-
variable taken individually is significant, it is pertinent to show
~~~~~~~~~~~CD.)~~~~~~~~~~~~~~~~~~~~~~~~~~~~~,'
the joint significance of these variables. Below each model, we
provide the P-value of F-statistics for the joint hypothesis that
0)

C.C
all the three insider ownership coefficients are jointly zero (i e,
o " joint exclusion test). For model 1, the P-value is 0.00 which rules
out the null hypothesis.
In Figure 2; we plot the predicted Tobin's Q and insider share.
The graph shows that corporate value increases with insider
ownership but begins to decline at higher levels of ownership.
r .4
Finally, corporate value increases at very high levels of insider
0 .2 .4 .6 .8 1
ownership. Our finding is consistent with convergence of interest
Insider Ownership
and entrenchment effects at increasing levels of insider owner-
ship. When we have calculated the turning points for this baseline
*-- pred_Q ---- lower ........ Upper
specification, the turning points on the cubic function of insider
share are at 0.29 (maxima) and 0.56 (minima).
which has been used as follows: In the case of US firms, McConnell and Servaes (1990) find
a significant concave relationship between managerial ownership
Performancet= a + (1 (Ins.spl)it + 32 (Ins.sp2)it + P3 (Ins.sp3)it
+ ylLn(s)it + Y2Ln(s)2 + Y3(Y/S)i, + Y4(LEV)it + y5(LEV)2it and firm value. In their sample for 1976, the maximum is reached
when insider ownership is 49.4 per cent and it is 37.6 per cent
+ 6(R&D/K)it+Y7(ADV/K)it +8(VK)it+ yg(KS)it +YoLn(age)it for 1986. To note here, McConnell and Servaes have considered
+ y l(FORPRES)it + y 2(FORS26 - 51%)it + yl3(FORS > 51%)it a quadratic equation model which can only test for bell shapes
+ y14(BSE500)it + ,t + +t + Eit that cover the entire ownership interval from 0 to 100 per cent.
We have generated variables containing a linear spline of
However, the evidence provided by MSV (1988) using a piece-
wise linear regression shows that the relationship is cubic.
insider ownership with two knots at 0.20 and 0.49. More formally,
Consequently, regressing squared insider ownership will result
let INSi, i=l,...,n, be the variables to be created ki, i=l,...,n-1
be the corresponding knots, and INS (insider share) be the original
in a model specification error, if the relationship is of a cubic
form. Short and Keasey (1999) using a third degree polynomial
variable. Then, INS l = min (INS,kl) and INSj = max { min(INS,ki),
find the maxima at 13 per cent and minima at 42 per cent in
kil) -ki-l where i=2,...,n. In the marginal spline specification,
the definitions are: the firm value model for UK firms. Similarly, Faccio and Lasfer
INS1 = INS and INSi = max(0,INS - kil) where i=2,...,n.
Marginal specification is preferred as when the generated vari-Table 3: Pooling Data OLS Regression Estimates of Tobin's Q
ables are used in estimation, its coefficient represents the change on Insider Ownership and Other Firm Characteristics
in the slope from the preceding interval. For example, Ins.sp2 Pooled Data (Dependent Variable: TcJin's Q)
Variable Model 1 Model 2 Model 3 Model 4
in the marginal specification shows the change in slope from after
insider ownership 0.20 to before insider ownership 0.49. So, INS
it 1.1574(3.60)* 0.7751(2.53)* 0.7227(2.36)* 0.9326(3.07)*
INSSQ -3.0371(-3.81)* -1.9550(-2.56)* -1.9466(-2.55)* -2.4861(-3.30)*
tests for the differences in slopes. In the non-marginal spline
INSCU 2.3769(4.03)* 1.7023(2.99)* 1.6932(2.98)* 1.9950(3.55)*
specification, Ins.sp2 would have measured the slopes for the LN(S) -0.0604(-4.81)* -0.0635(-5.03)* -0.0631(-5.04)*
interval, i e, 0.20 to 0.49. Another advantage of this is that LN(S)2
it 0.0071(3.42)* 0.0074(3.59)* 0.0073(3.60)*
Y/S 0.0005(1.55)? 0.0005(1.70)** 0.0007(2.05)*
makes it possible to test whether the change in slope is significant,
LEV 0.6270(10.77)* 0.6402(11.22)* 0.6828(12.22)*
i e, if the effect of ins.sp2 is not significant then the effect ofLEVSQ - 0.0988(2.84)* 0.0913(2.73)* 0.0863(2.67)*
R&D/K - 4.6277(5.15)* 4.5609(5.08)* 4.5621(5.15)*
insider ownership does not change after the break point.
ADV/K - 0.0623(2.30)* 0.0618(2.34)* 0.0566(2.33)*
I/K - 0.0381(1.76)** 0.0417(1.84)** 0.0443(1.88)**
K/S - -0.0003(-1.99)* -0.0004(-2.38)* -0.0004(-2.38)*
Empirical Results and Analysis LN(AGE) - -0.0275(-2.10)* -0.0290(-2.21)* -0.0348(-2.66)*
LIQUIDITY - 15.5405(3.79)* 15.9149(3.87)* 16.3626(3.97)*
In Table 3, we report the pooled ordinary least squares FORPRES - - 0.1403(6.64)*
(OLS)
FORS:
result of insider ownership and firm performance in four different
26-51per cent - - - 0.2013(5.30)*
model specifications, i e, models 1-4. The first model reports
FORS:
>51 per cent - - 0..4084(7.15)*
the results from a baseline specification using only ownership
BSE 500 - 0.4130(13.24)* 0.3903(12.32)* 0.3666(11.47)*
variables in which Tobin's Q is regressed on insider ownership
R-square 0.0046 0.2109 0.2170 0.2297
F Stat: Prob > F 0.00 0.00 0.00 0.00
(INS), insider ownership squared (INSSQ) and insider ownership
Prob>F:
cubed (INSCU). In the parenthesis, below each coefficient, we(insider)# 0.00 0.00 0.00 0.00
report the heteroskedasticity consistent t-statistics. Year dummy: NO Yes Yes Yes
Obs. 7329 7305 7305 7305
The results from model I confirm our hypothesis that the
relationship between the performance of firms and insider Notes: Heteroskedasticity c
errors are calculated us
ownership is cubic in form. The point estimate of each ownership variance-covariance matrix.
variable is statistically significant. The coefficients on INS and * Indicates significance at 5 per cent level, ** indicates significance at
INS3 are positive while that on INS2 is negative. This result pro- 10 per cent level, ? indicates significance at 15 per cent level.
# For models P-value of joint exclusion test of insider ownership is
vides support for the general functional form of the relationship given, for which the null hypothesis is that all the insider-ownership
between firm value and insider ownership that is management variables are jointly zero.

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 Figure 3: Operational Efficiency Score [Pant and Pattanayak 2005], we find the absence of scale econo-
(Operating Expense Ratio and Asset Turnover)
mies in Indian industry. Therefore, internal capital market ad-
5 vantages [as suggested by Short and Keasey 1999] and
organisational efficiency of large firms [Williamson 1985] may
4- be the reason for a higher Q-ratio.
In Figure 3, we show the average operational efficiency of a firm
uo
(3-3 on the basis of the operating expense ratio and asset turnover.
The x-axis shows the size decile (measured by sales) of the firm
-2 and the y-axis measures the efficiency score. It is apparent from
the figure that the operating expense ratio declines with an in-
crease in the size of firms. On the other hand, as the size of the firm

0- increases, the asset turnover ratio increases. Therefore, this suggests

that large firms are operationally more efficient than small firms.
0 2 4 6 8 10
Leverage or debt intensity is positive as the point estimate is
Firm Size (Deciles)
0.63 with high statistical significance. To test for non-linearity,
-- Av_opexp --- Av_assturn
the models include a squared leverage term which is also positive
(2000) document the turning points at 19.68 per cent (maxima) and statistically significant in model 2. A high commitment of
and 54.12 per cent (minima) in UK firms. In the case of India,fixed debt payment helps in alleviating the excess cash flow
Sarkar and Sarkar (2000), using a piece-wise linear model, find
problems. This is also consistent with the signalling argument
[Ross 1977] and free cash flow theory [Jensen 1986]. Next, the
the firm value to decrease till 25 per cent of insider share and
to increase thereafter. Deb and Chaturvedula (2004), studying coefficient of research and development (R&D) intensity is
433 firms of Standard and Poor's CNX 500 for the year 2003, positive and statistically significant. Here, we see that higher
document that in India firm value increases up to 30 per cent spending in R&D leads to a higher Q-ratio which suggests that
of insider ownership and between 30 and 60 per cent firm valuehigh R&D firms are innovative and profitable. The point estimate
decreases, which increases thereafter. In India, as the above of advertising or promotional expenditure is 0.06 and statistically
significant at less than 1 per cent level. Advertising expenditure
mentioned study shows and our findings also confirm, managers/
insiders entrench at a very high level of ownership. This dif-
captures the effect of intangible assets along with R&D expense.
These variables control for an upward bias in the Q-ratio that
ference in findings could be attributed to institutional differences
between advanced countries and India [Short and Keasey 1999; result from the use of book value of total assets in the denominator
Faccio and Lasfer 2000]. Several studies documented that of Q-ratio. Higher expenditure in advertising helps firms in
ownership in the US is less concentrated [Denis and McConnell building their reputation and also acts as an entry deterrent for
2003; Roe 2005; La Porta et al 1998]. A highly diffused ownership new entrants in the industry.
structure enables the manager or insider to entrench at low levels Current expenditure in fixed capital (I/K) is found to be positive
of shareholding as non-insider shareholdings are diffused [MSV and significant. We used the variable "age" to control for life
1988]. Second, as MSV (1988), Agrawal and Knoeber (1996)cycle effects. As in other studies, we find younger firms to be
and Cho (1998) have collected samples from Fortune 500 list, more valuable than older firms. The final variable in model 2
i e, large firms, it is not surprising to see managers to entrench is BSE 500, a categorical variable equal to 1 if the firm is one
at low levels of insider ownership because major block holdings of the Bombay Stock Exchange 500 (BSE 500) firms. As ex-
will be absent in such firms. pected, we find the dummy variable to be positive and highly
In India, as we have already seen, ownership is highly significant.
con- On an average, the market value of BSE 500 firms
centrated. This governance structure allows insiders to entrench is 41 per cent more in comparison to non-BSE 500 firms.
only at higher levels of ownership. When insiders have fewer stakes In model 3, we include another categorical variable, i e, foreign
in the firm, there may be some other block-holders who prevent presence (FORPRES). If the promoter shareholding includes
them from dissipating shareholders' wealth. Stulz's (1988)shares rea- of a foreign promoter/collaborator, we code it as 1 otherwise
soning is also quite appealing in the context of India, although zero.
fromA foreign promoter/collaborator is a strategic partner for a
a different perspective. When insiders have lower stakes in a domestic
firm, corporation when he provides superior technology
the likelihood of a successful takeover is quite high, thus forcingknow-how. The technological and organisational advantages of
insiders to perform. However, once they have a substantial foreign stake firms and their ability to operate internationally brings
in the firm so that the probability of a takeover is low, theyreputational
may advantages vis-a-vis domestically owned firms. In our
sample, there are 345 firms with foreign promoter/collaborator share-
try to consume or divert the firm's resources at the cost of ordinary
shareholders. In reality, the market for corporate control holding.
is at The categorical variable shows that firms with a foreign
its nascent stage in India [Chojer 2005; Raju et al 2004].promoter share tend to have higher market value. Operating income
In model 2, we have used several control variables and isyear
positive and statistically significant. It is a measure of profita-
dummy. The sign and significance of ownership variables remainbility and measured as the ratio of cash profit to sales. Consistent
unaltered. Our result also indicates a convex non-linear impact
with our expectation, the firm value is higher; the higher is the profit
of firm size (i e, sales) on firm value. Firm value (Q-ratio) rate
firstof the firm. For all other variables, the signs and significance
decreases and then increases in log of sales salese) which is
remain intact. When we calculate the turning points of insider
share in model 3 (after including several control variables), the
consistent with the curvilinear findings of HHP (1999). Whether
economies of scale or organisational efficiency (X-efficiency)turning points are found at 0.32 (maxima) and 0.45 (minima).
Chhibber and Majumdar (1999) confirm that before 1991,
is the reason for positive association of value and size for large
foreign ownership has no discernible impact on firm profitability
firms require a more scientific investigation. In an earlier study

1464 Economic and Political Weekly April 21, 2007

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 Figure 4: Predicted Tobin's Q and Insider Share are found at 0.30 (maxima) and 0.52 (minima). Models 6,7 and 8
(Fixed effect estimation with control variables)
are the replication of models 2, 3 and 4 with industry fixed effects.
c 1.2- All the ownership variables signs and significance confirm to
a'
earlier model results. However, the effect of current expenditure
a) ;
in fixed assets (I/K) on firm value disappears at the conventional
level of significance once we control for industry effects. Age
has no statistically significant impact on firm value in these
a, models. Firm value is found to be monotonically increasing with
:.4 leverage. It is revealing as most of the previous studies on India
find a negative effect of debt holding on profitability. Confirming
our previous models, we find the coefficient of Isales to be
negative and lsales2 to be positive.
CL .4-
In Figure 4, we plot the predicted Tobin's Q and insider
0 .2 .4 .6 .8 1
ownership for the model 8. Unlike in the figure, here we include
Insider Ownership
all control variables and industry effects. We find the value of
---- pred_q -- lower ...... upper
maxima at 0.32 of insider ownership and minima at 0.52.
This is due to several restrictions on the amount of foreign
holdings in the firm. Post-1991, they find foreign ownership
Models with Spline Specification
influences profit rate positively only when foreign stake exceeds
51 per cent in the firm. Any foreign stake less than Following
51 per centMSV (1988) we adopt a piecewise linear model to
exactly identify
has no significant impact on profitability. To test Chhibber and the non-monotonicity in the relation between
Majumdar's findings here, we have generated three categorical
insider stock ownership and firm performance. This model allows
variable, i e, FORS<26 percent, FORS26-51 percent and FORS>51
for the effect of holdings to change at different threshold points
per cent. The first dummy variable. i e, FORS<26 per cent
known is nodes. A piecewise linear specification and/or
as spline
our base category. In model 4, the other two dummy variables
cubic model is better than a quadratic functional form to test for
have positive sign with high statistical significance. Unlike
non-monotonicity in the ownership and performance relation-
Chhibber and Majumdar (1999) we find even when ship.foreign
However, it is difficult to say whether the piecewise speci-
fication
promoter stake lies between 26 per cent and 51 per cent, or cubic regression model is better. Even though Morck
the firms
exhibit higher Q-ratios. et al used the piecewise functional form as early as 1988, authors
like McConnell and Servaes (2005) and Short and Keasey (1999)
Models with Industry Fixed Effects adopt a quadratic or cubic functional form in their study. There-
fore it is a matter of choice or convenience to choose the model
in one's
In such kind of studies it is inevitable to control for study. In a spline specification, one can choose the knots
industry
effects as the incentive alignment and entrenchment problems
differ across investment opportunity sets. Also, panel Table 4: Fixed Effects Regression Estimates of Tobin's Q on
estimation
Insider Ownership and Other Firm Characteristics
allows one to control for industry specific shocks and a firm's
sensitivity to such shocks which is not possible in cross-section Dependent Variable: Tobin's Q
Industry Fixed Effects
data. To avoid possible spurious correlation betwen ownership
Variable Model 5 Model 6 Model 7 Model 8
and the Q-ratio through industry effects we have used a two-
INS 1.0216(3.11)' 0.7533(2.42)* 0.7049(2.26)* 0.9452(3.05)*
digit level industry dummy based on national industrial classi-
INSSQ -2.6574(-3.35)* -1.7712(-2.34)* -1.7868(-2.36)* -2.3905(-3.19)*
fication (1998) which is akin to standard industrial classification
INSCU 2.1500(3.70)* 1.5422(2.77)* 1.5536(2.79)* 1.8943(3.44)*
LN(S)
(SIC). For the sae of brevity, we have not reported the - -0.0679(-5.23)* -0.0694(-5.35)* -0.0683(-5.32)*
intercept
LN(S)2 0.0086(4.05)* 0.0087(4.13)* 0.0086(4.13)*
as each industry has its own intercept. Using firm level fixed
Y/S 0.0005(1.62)** 0.0005(1.69)** 0.0007(2.07)*
LEVvariation
effects is problematic as it removes all cross-section 0.7117(12.57)* 0.7206(12.94)* 0.7668(14.06)*
LEVSQ 0.0817(2.56)* 0.0754(2.45)* 0.0694(2.33)*
which is important in the present study. Firm specificR&D/K dummy
4.1301(4.63)* 4.1119(4.60)* 4.1453(4.68)*
variables eliminate all between firm variations from the data. It ADV/K - 0.0608(2.30)* 0.0601(2.33)* 0.0545(2.32)*
I/K 0.0213(1.23) 0.0250(1.38) 0.0266(1.43)?
only exploits the within group variation in the data as the
K/S -0.0004(-2.52)* -0.0004(-2.78)* -0.0005(-2.77)*
mean demeaning procedure eliminates between variation. Since LN(AGE) - 0.0037(0.27) 0.0026(0.19) -0.0006(-0.04)
LIQUIDITY - 11.3492(2.66)* 11.8262(2.77)* 12.1547(2.85)*
the cross-sectional variation is important in governance studies,
FORPRES - 0.1397(6.41)*
we prefer the industry dummy rather than firm level dummy FORS>26percent - - - 0.1943(5.09)*
FORS>51percent - - 0..4170(7.26)*
variables [Hermalin and Weisbach 1991, Zhou 2001]. The in-
BSE 500 - 0.3991(12.89)* 0.3780(12.07)* 0.3550(11.26)*
dustry dummy exploits the within variation in each sector
Adj R-square 0.0336 0.2288 0.2344 0.2470
across the firms. F Stat: Prob > F 0.00 0.00 0.00 0.00
Prob>F:(insider)# 0.00 0.00 0.00 0.00
The results with industry specific fixed effects are presented Year dummy: No Yes Yes Yes
in four a model specification, models 5 to 8 in Table 4. Model 5Obs 7329 7305 7305 7305
is the replication of model 1 without any control variables. As Notes: Heteroskedasticity c
per our hypothi thesis, the signs of INS and INS3 are positive and errors are calculated us
variance-covariance matrix.
sign of INS2 is negative. It confirms our previous findings that *Indicates significance at 5 per cent level, ** indicates significance at
insiders move from alignment, to entrenchment to alignment as 10 per cent level, ? indicates significance at 15 per cent level.
# For models, P-value of joint exclusion test of insider ownership is
their ownership stake in the firm increases. All the ownership given, for which the null hypothesis is that all the insider-ownership
variables found to be jointly significant. Here, the turning points variables are jointly zero.

Economic and Political Weekly April 21, 2007 1465

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as per certain practical reasons and it is amenable to comparison
with previous studies. In this study we choose the knots at [0-
0.20], [0.20-0.49] and above 0.49. As MSV (1988) state, the
chosen nodes are arbitrary. However, here we have tried to link
with the Indian property rights regime as per the companies act,
1956. Also, the chosen knots, to some extent, are being influenced
by our cubic model results. The three model specifications are
given in models 9-11 in Table 5.
The first model in Table 5 is considered for a comparison
purpose with the next two models. When shareholding level is
less than 26 per cent, one cannot block special resolutions. When
shareholdings go beyond 26 per cent, one can stop the passing
of a special resolution. A special resolution requires the support
of three-fourths majority of shareholders present and entitled to
voting as per section 189 of Indian Companies Act, 1956. When
the shareholding level exceeds 50 per cent, one can pass ordinary
resolutions which govern most of the activities of the firm. Thus
varying degrees of control power are associated with each level
of ownership stake, thus we expect its effect to be reflected in
firm performance. Accordingly we have generated three spline
nodes at [0-0.26], [0.26-0.51] and above in model 9. As we can
see in the model, the sign of each ownership variable is as per
our hypothesis, i e, Ins spl and Ins sp3 are positive and Ins sp2
is negative. According to our hypothesis, insiders perform at very
low and high levels of shareholding but shirk at the medium level
of holding. However, none of the ownership variables is signifi-
cant at the conventional level of significance.
In models 10 and 11, the spline nodes are fixed at [0-0.20],
[0.20-0.49] and above. We have selected the cut-off point after
extensive search at several points, including the turning points
that emerged in our cubic estimation. Like MSV (1988) we rely
on the model where we find the root mean square error to be
minimum. In our cubic model, we find the values of maxima
to vary from 0.28 to 0.32 and the values of minima to vary from
0.45 to 0.54. But the spline specification best fits the aforemen-
tioned range. Here 0.20 is much below 0.26 but 0.49 is only .02
point less than 0.51 where one gets simple majority. However,
once insiders have a 20 per cent share or more, they have enough
property rights and they can collude with some small stakeholders
to block special resolutions when they want so.
Our baseline specification, which does not include any control
variables is model 10. We report heteroskedasticity consistent
t-statistics below each estimated coefficients. As per the hypoth-
esis of the study, we see the firm value to increase when insider
stake is less than 20 per cent and beyond 49 per cent but it declines
in the range of 20 to 49 percent. In model 11, all of the explanatory
variables are included. The sign and significance of each own-
ership coefficient is consistent with our previous findings. For
each 1 per cent increase in ownership between 0 and 20 per cent,
firm value increases by an average 0.005 and for each percent
increase in ownership from 20 per cent to 49 per cent, firm value
declines by 0.007 points. The coefficient of Ins sp2 shows the
change in slope from the preceding interval, i e, 0-0.20. It is -
0.677 and statistically significant. As insider stake increases
beyond 49 per cent, we find an increase in the Q-ratio but at
a slower rate of 0.003 for each 1 per cent increase in ownership.
Therefore, when ownership goes above 49 per cent, the differ-
ential impact or the marginal change in slope is positive and
significant. The joint exclusion test of insider ownership variables
confirms that all three insider ownership variables taken together
are significant.
1466 Economic and Political Weekly April 21, 2007
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VI
Summary and Conclusion
This study confirms that with an increase in insider ownership
stake, firm value initially increases. At the initial level of ownership,
either insiders do not have a substantial stake to entrench them-
selves or they have incentives to perform more to acquire more
ownership stakes. The market discipline may force the insiders
to pursue value maximisation, despite their lack of personal
incentives to do so at this low level of stake in the firm. Also,
it is possible that they want to show their performance; otherwise
they may be targeted by some other management group for
takeover. But, when their stake exceeds 20 per cent they have
a reasonably high stake in the firm. They play a crucial role in
the decision-making process of the firm. They have the incentive
to consume at office or divert firm resources to the entity where
they have exclusive ownership right. With a substantial fraction
of firm shares, which confers enough voting power, they may
satisfy their value non-maximising objectives without endanger-
ing their position in the firm.
It is very hard to note the exact source of entrenchment as earlier
studies ascribed it to a number of factors: status as a founder,
increasing voting power, increased tenure with attachment to the
firm, lower employment of professional managers, and domi-
nance of insider over outside directors in the board. As and when
their ownership stake goes beyond 49 per cent, there is a con-
vergence of interest with the firm. They have very high interest
in the firm as they have to bear maximum loss for each dollar
loss. Also, as per the monitoring hypothesis, with greater own-
ership stake insiders keep an eye on other constituents of the
firm and the firm gets rid of the free rider problem associated
Table 5: Piecewise Linear Fixed Effects Regression of
Tobin's Q on Insider Ownership and Other Firm Characteristics
Industry Fixed Effects
(Dependent Variable: Tobin's Q)
Variable Model 9$ Model 10 Model 11
Ins.spl 0.1618(0.91) 0.5892(2.31)* 0.5460(2.37)*
Ins.sp2 -0.1404(-0.61) -0.6775(-2.04)* -0.6140(-2.11)*
Ins.sp3 0.2738(1.63)? 0.4386(2.38)* 0.3689(2.21)*
LN(S) -0.0705(-5.45)* - -0.0697(-5.44)*
LN(S)2 0.0087(4.16)* - 0.0086(4.15)*
Y/S 0.0007(2.13)* - 0.0007(2.11)*
LEV 0.7780(14.40)* - 0.7764(14.38)*
LEVSQ 0.0674(2.28)* - 0.0678(2.29)*
R&D/K 4.1316(4.67)* - 4.1211(4.66)*
ADV/K 0.0554(2.35)* - 0.0553(2.34)*
I/K 0.0261(1.40) - 0.0258(1.39)
K/S -0.0005(-2.79)* - -0.0005(-2.79)*
LN(AGE) 0.0010(0.07) - 0.0018(0.13)
LIQUIDITY 12.2702(2.88)* - 12.2083(2.86)*
FORPRES
FORS >26 per cent 0.1964(5.13)* - 0.1973(5.16)*
FORS >51 per cent 0.4109(7.11)* - 0.4111(7.10)*
BSE 500 0.3565(11.26)* - 0.3567(11.26)*
Adj R-square 0.2455 0.0389 0.2458
F Stat: Prob > F 0.00 0.00 0.00
Prob>F: (insider)# 0.00 0.00 0.00
Year dummy: Yes Yes Yes
Obs 7305 7329 7305
Notes: Heteroskedasti
errors are calculat
variance-covariance matrix.
*Indicates significance at 5 per cent level, ** indicates significance at
10 per cent level, ? indicates significance at 15 per cent level.
# For models, P-value of joint exclusion test of insider ownership is
given, for which the null hypothesis is that all the insider-ownership
variables are jointly zero.
$ Model 9 is adopted following India's corporate law or legal regime
where certain control rights devolve at (0-0.26), (0.26-0.51) and above.
 with dispersed ownership. Unlike other Asian countries, concen- 'Were the Good Old Days That Good? Changes in Managerial Stock
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