The dynamic relationship between managerial ownership and firms performance in vietnams

UNIVERSITY OF ECONOMICS

INSTITUDE OF SOCIAL STUDIES

HO CHI MINH CITY

THE HAGUE

VIETNAM

THE NETHERLANDS

VIETNAM- NETHERLANDS
PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE DYNAMIC RELATIONSHIP BETWEEN
MANAGERIAL OWNERSHIP AND
FIRM’S PERFORMANCE IN VIETNAM
BY
NGUYEN THI THANH AN

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, NOVEMBER 2016


UNIVERSITY OF ECONOMICS

INSTITUDE OD SOCIAL STUDIES

HO CHI MINH CITY

THE HAGUE

VIETNAM

THE NETHERLANDS

VIETNAM- NETHERLANDS
PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE DYNAMIC RELATIONSHIP BETWEEN
MANAGERIAL OWNERSHIP AND
FIRM’S PERFORMANCE IN VIETNAM
A thesis submitted in partial fulfillment of the requirements for the degree of
MASTER OF ARTS IN DEVELOPMENT ECONOMICS

By
NGUYEN THI THANH AN

Academic Supervisor
Dr. VO HONG DUC

Ho Chi Minh City, November 2016


DECLARATION
The work in this dissertation entitled “The dynamic relationship between managerial
ownership and firm’s performance in Vietnam” which has been implemented by me to
fulfill the requirement of Master of Art in Development Economics at Vietnam - The
Netherlands Programme.

I hereby certify that this thesis is a result of my own efforts, and any sources would be
acknowledged. This is original research which have been submitted neither whole nor a part
of research for any other degree.

HCMC, November, 2016

Nguyen Thi Thanh An

i


ACKNOWLEDGEMENTS
First of all, the thesis had implemented with the assistance and encouragement of my
principal supervisor Dr. Vo Hong Duc. I would like to emphasize the thankful gratitude and
appreciation to him. His guidance helps me develop my dissertation throughout all stages of
processing thesis. He also devotes his valuable time for me and my team to encourage and
share his experience in study as well as in real life.
In addition, I would like thank Dr. Truong Dang Thuy who is patient and sympathetic in
provision of econometric technique and supporting in any question. My thanks also go to all
of staffs at VNP, especially Ms. Xuan Hong has already assisted the students with her
dedication.
Furthermore, I also acknowledged all of classmates in Class 21. I had the opportunity to
work and learn in an intimate and supportive class.
Above all, I most deeply thank to my parents who always support in any project and
intention and love me without condition over 26 years.

HCMC, November, 2016

Nguyen Thi Thanh An

ii


ABSTRACT
Corporate governance is generally considered as a key factor for the operational success
for enterprises. One of the most frequently discussed concepts among corporate governance
factors is the ownership structure, in particular, managerial ownership. Various empirical
studies have been conducted to consider and examine the impact of diverse ownership
structure aspects on firm’s performance which is proxied by various dimensions including
accounting return, market evaluation and probability of bankruptcy.
Findings from various empirical studies on the above issue are mixed due to the
following reasons. First, it is difficult to capture appropriately the power of managers in
making decisions. In the developing countries, managers also control the firm via the
ownership of related parties. As such, this study is conducted to measure managerial
ownership in terms of (i) direct ownership and (ii) indirect ownership to achieve the better
measurement. Second, many authors argued that managerial ownership should be treated as
endogenous parameter and the relationship between managerial ownership and firm’s
performance is non-monotonic. To deal with endogeneity of managerial ownership, this study
focuses on the effect of the change in managerial ownership (managers’ decision to
purchasing and selling stocks) on the change in firm’s performance.
To achieve these objectives, a panel data of 285 listed firms on Ho Chi Minh City Stock
Exchange (HOSE) for the period from 2010 to 2015 is utilized. Findings from this study
indicate that the percentage of stocks owned by managers and their related parties
significantly fluctuated. In addition, the actual managerial ownership level tends to move
away from the optimal level due to the existence of adjustment costs. Furthermore, managers
are likely to sell stock when the entire financial market performed well. Notwithstanding, the
managers do not purchase stoFcks in the case of illiquid market and deteriorating
performance. Findings from this study also present evidence to confirm the view that the
reduction of lagged managerial ownership level would send a signal in relation to the quality
of firm, and would also provide the negative impact on firm’s performance regarding market

evaluation. However, the study fails to provide empirical evidence in relation to the change in
managerial ownership against the change in firm’s return on total assets the accounting- based
measurement.
Key words:

Managerial ownership, Firm’s performance, Endogeneity, Market-based
measurement, Accounting-based measurement.
iii


TABLE OF CONTENTS
DECLARATION .............................................................................................................. i
ACKNOWLEDGEMENTS ..............................................................................................ii
ABSTRACT ................................................................................................................... iii
TABLE OF CONTENTS ................................................................................................ iv
LIST OF TABLES .........................................................................................................vii
LIST OF FIGURES ..................................................................................................... viii
LIST OF ABBREVIATION ............................................................................................ ix
CHAPTER 1 INTRODUCTION ...................................................................................... 1
1.1

Problem statement ................................................................................................... 1

1.2

Research objectives ................................................................................................. 3

1.3

Research questions .................................................................................................. 3

1.4

Contributions of the thesis ....................................................................................... 4

1.5

Research Scope ........................................................................................................ 4

1.6

Structure of the thesis .............................................................................................. 4

CHAPTER 2 LITERATURE REVIEW........................................................................... 6
2.1

The theoretical background of managerial ownership and firm’s performance. ..... 6

2.1.1 The agency approach ................................................................................................. 6
2.1.1.1 The incentive effect ........................................................................................ 7
2.1.1.2 The entrenchment effect ................................................................................. 7
2.1.2 The managerial discretion approach ........................................................................... 8
2.1.3 The timing approach ................................................................................................ 10
2.2

Endogeneity of managerial ownership................................................................... 10

iv

2.3

The empirical evidences of relationship between managerial ownership and firm’s
performance and limitations ................................................................................. 12

2.3.1 The research in worldwide and the limitations ........................................................... 12
2.3.1.1 The exogenous managerial ownership ........................................................... 12
2.3.1.2 The endogenous managerial ownership ......................................................... 14
2.3.2 The empirical evidence in Vietnam........................................................................... 17
2.4

The corporate governance of Vietnamese listed firms ........................................... 18

2.5 The conceptual framework .................................................................................... 21
CHAPTER 3 RESEARCH METHODOLOGY AND DATA ......................................... 22
3.1

Data sources .......................................................................................................... 22

3.2

Measurement variables ......................................................................................... 23

3.2.1 Definition and measurements of firm’s performance.................................................. 23
3.2.1.1 Accounting – based measurements ................................................................ 23
3.2.1.2 Market–based measurements ........................................................................ 24
3.2.2 Definition and measurement of managerial ownership ............................................... 24
3.3

Research methodology ........................................................................................... 25

3.4

The empirical model .............................................................................................. 26

3.4.1 The determinants of firm’s performance and optimal managerial ownership ............... 26
3.4.1.1 The determinants of firm’s performance ........................................................ 26
3.4.1.2 The determinants of optimal managerial ownership level ............................... 28
3.4.1.3 The movement of actual managerial ownership ............................................ 31
3.4.2 The explanation of the large change in managerial ownership. ................................... 32
3.4.3 The dynamic relationship between managerial ownership and firm’s

performance. .. 34

CHAPTER 4 RESULTS AND DISCUSSIONS .............................................................. 36
4.1

Data description .................................................................................................... 36
v


4.1.1 Descriptive statistics ............................................................................................... 36
4.1.2 Correlation analysis ................................................................................................. 41
4.2

The determinants and movement of managerial ownership .................................. 41

4.2.1 The determinants of managerial ownership ............................................................... 44
4.2.2 The movement of actual managerial ownership. ........................................................ 46
4.3

The explanation of the large change (decrease or increase) ................................... 47

4.3.1 The statistics by group ............................................................................................. 47
4.3.2 The likelihood regression of large change (increase or decrease) against the change in
firms’ characteristics and market condition. .............................................................. 50
4.4

Dynamics of managerial ownership and firm’s performance. ............................... 53

4.4.1 Firm’s performance: accounting-based measurement ................................................. 53
4.4.2 Firm’s performance: market-based measurement. ...................................................... 55
CHAPTER 5 CONCLUSIONS AND POLICY IMPLICATIONS ................................. 60
5.1

Concluding remarks .............................................................................................. 60

5.2

Policy implications................................................................................................. 61

5.2.1 The implications for enterprises ............................................................................... 61
5.2.2 The implications for Vietnam’s authority and the Government .................................. 62
5.3

The limitations and further research. .................................................................... 62

5.3.1 The limitations ........................................................................................................ 62
5.3.2 The further research ................................................................................................ 62
REFERENCES .............................................................................................................. 64

APPENDICES................................................................................................................ 70

vi


LIST OF TABLES
Table 3.1

Tests are ultilized to find the appropriate model .............................................. 26

Table 3.2

The determinants of optimal managerial ownership level. ............................... 28

Table 3.3

The summary of variables employed in Probit model. ..................................... 32

Table 4.1

Summary statistics of firm’s characteristics of 285 firms listed on HOSE from
2010 to 2015) period. ........................................................................................ 37

Table 4.2

Statistical summary of variables separated by year. ......................................... 38

Table 4.3

Statistical summary of variables separated by industry .................................... 39

Table 4.4

Correlation coefficients between managerial ownership and firm’s attributes. 40

Table 4.5

The relationship between level of managerial ownership and firm’s
performance. ..................................................................................................... 43

Table 4.6

The determinants of managerial ownership level. ............................................ 45

Table 4.7

The movement actual mangerial ownership level toward to estimated optimal
level. .................................................................................................................. 46

Table 4.8

Statistical summary of data by data source. ...................................................... 49

Table 4.9

Large change in managerial ownership against change in firm’s attributes and
market condition. .............................................................................................. 52

Table 4.10

The effect of lagged managerial ownership change on firm’s performance
change in terms of accounting-based measurement.......................................... 53

Table 4.11

The effect of lagged change in managerial ownership on firm’s performance in
terms of market-based measurement. ............................................................... 57

vii


LIST OF FIGURES
Figure 1.1

The relationship between insider ownership and firm’s performance. ............... 8

Figure 1.2

The management structure of shareholding company ...................................... 19

Figure 1.3

The internal governance structure of a listed company .................................... 20

Figure 1.4

The conceptual framework ............................................................................... 21

Figure 4.1

The nonlinear relation between the lagged change in managerial ownership and
the change in return on total assets (ROA) ....................................................... 53

Figure 4.2

The nonlinear relation between the lagged change in managerial ownership and
the change in market evaluation of firm’s performance (Tobin’s Q) ............... 55

viii


LIST OF ABBREVIATION
AMEX

American Stock Exchange

CEO

Chief Executive Officer

GMM

Generalized method of moments

GMS

General Meeting of Shareholders

FE

Fixed effect

FGLS

Flexible generalized least squares

FP

Firm’s performance

HNX

Hanoi Stock Exchange

HOSE

Ho Chi Minh Stock Exchange

IFC

International Finance Corporation

IV

Instrument variable

MO

Managerial ownership

MV

Market value

NASDAQ

National Association of Securities Dealers Automated Quotations

NYSE

New York Stock Exchange

OLS

Ordinary least square

R&D

Research & Development

RE

Random effect

ROA

Return on assets

ROE

Return on equity

P/E

Price/ Earnings ratio

SEC

Securities and Exchange Act

2SLS

Two Stage Least Square

SSC

State Securities Commission

UPCOM

Unlisted Public Company Market

ix


Chapter 1
INTRODUCTION
1.1

Problem statement

In corporate world, the separation between principals (owners) and the agents

(managers), or the ownership and control of the firm, induces the agency problem. Managerial
ownership could generally be used as an effective mechanism to reduce this problem. As
such, the optimal level of managerial ownership has attracted great attention from both
academics and practitioners in a modern corporate governance framework. The ultimate
objective of any firm is to maximize the firm’s value or to maximize owner’s propensity.
However, in some cases, under managerial discretion, they will maximize their welfare
(Kuhnen & Zwiebel, 2006; Lambrecht & Myer, 2007). Three considerable approaches which
have been used to attempt to explain the mechanism of impact of managerial ownership on
firm’s performance: (i) agency approach, (ii) managerial discretion approach, and (iii) timing
approach. Most of the empirical studies presented a non-linear relationship between
managerial ownership and firm’s performance. McConnell and Servaes (1990) found the
reversed U-shaped relationship between Tobin’s Q and the level of insider ownership. MO
also provides a positive effect on firm’s performance up to the threshold of 40 percent to 50
percent. Morck, Shleifer, and Vishny (1988) examined this relationship with sectional data of
500 Fortune firms and concluded that the W-shaped between the level of MO and Tobin’s Q
was found. However, Kole (1995) and Himmelberg, Hubbard, and Palia (1999) argued that
cross-sectional data cannot capture adequately the change in firm’s environment and
endogeneity of MO. Many recent studies attempted to deal with endogeneity issue of MO
with different approaches, however, some limitations still exists and many arguments in
interpretation the result provoked.
Kole and Lehn (1997) addressed an important issue of governance structure that has
change over time. They also investigated the question as to what forces drive the change. In
reality, Holderness, Kroszner and Sheehan (1998) observed and detected the managerial
ownership in the US listed firms changed over time. Under similar circumstance, a new
approach in relation to the relationship between the change in managerial ownership and
firm’s performance via the change in Tobin’s Q in American firms investigated by
Fahlenbrach and Stulz (2008). The study attempted to examine the effect of the dynamic
1

change in managerial ownership on the change in firm’s performance which can help
eliminate endogeneity problem.
They also argued that the information about managerial ownership fully absorbed by the
market so change in managerial ownership in year t-1 affected to Tobin’s Q in year t. By
concentrating on the change in managerial ownership level year by year, the decision of
managers in selling and purchasing stock can be partially explained. In addition, by another
approach – event study, McConnell, Servaes and Lins (2008) found that managers did not
purchase share to move the optimal level as the explanation of agency approach. They also
provided the evidence to prove that managers (insiders) could not get the abnormal returns
which supported by the timing approach. The result was similar to Fahlenbrach and Stulz’s
study (2008), so it could be inferred that the change in managerial ownership was explained
partially by the managerial discretion theory.
In Vietnam, several studies investigated the impact of the structure of ownership
including the existence of state ownership, and foreign ownership on firm’s performance (Le
& Phung, 2013). Their findings were an inversed U-shaped relationship between state
ownership level and Tobin’s Q, and foreign ownership can boost firm’s performance. In
addition to that, the empirical results confirmed that there was no statistically significant
evidence of managerial ownership on firm’s performance in accounting- based measurement
(ROA, ROE) (Do & Wu, 2014; Nguyen & Giang, 2015). Nevertheless, the negative effect of
managerial ownership on firm’s performance in market aspects (P/E ratio) could come from
expropriation of block-holder. It will be impossible to capture absolutely the power of
managers via the proportion of their shares. In some cases, managers also have the power on
making decision in business via their relatives’ ownership and their represented stock of
certain organization. To the extent that, the existence of family –corporations in Vietnam are
not rare, and according to the survey of IFC (2012), family ownership provided negative
effect on accounting benefit rate. Family ownership is one of special block-holder in Vietnam
(Tsao, Chen, Lin, & Hye, 2009; Nguyen & Giang, 2015). While Holderness, Kroszner and
Sheehan (1998) defined the managerial ownership included direct and indirect ownership. To

be more specific, direct ownership indicated the percentage of stock which managers hold the
title, receives any pecuniary benefit from their ownership (including dividend, capital gain),
and they also exercise the voting right. Otherwise, indirect managerial ownership was
considered as the percentage of stocks held by their related people and their represented
organizations. The previous studies on the relationship between managerial ownership and
2


firm’s performance have limitation since they just captured the direct managerial ownership
which might not fully reflect managers’ power to make financial decision.
In Vietnam, the regulation of State Securities Commission (SSC) and the Enterprise
Law 2014 required disclosure information of managerial transaction themselves or their
related parties. The disclosure of information also helps author collect data of changes in
managerial ownership, but this collection is limited because it is time-consuming and
obtainable data is available in short time span. To sum up, the study attempts to provide better
understanding about the effect of managerial ownership on firm’s performance and an
explanation of managers’ decision of purchasing and selling stock.
1.2

Research objectives
The main aims of this study are two folds: (i) estimating the optimal level for

managerial ownership; and (ii) examining and quantifying the relationship between
managerial ownership and firm’s performance. In addition, this study attempts to explain the
behavior of managers and their relatives in relation to selling and purchasing firm’s share. As
such, the research objectives for this study can be summarized as below.
(i)

Estimating the optimal level for managerial ownership based on firm’s
characteristics and market’s environment;

(ii)

Observing the movement of actual managerial ownership level toward the optimal
level;

(iii) Figuring out the factors which impact the decisions on the selling and purchasing
stocks which have been used by the board of directors themselves and/or their
related parties;
(iv) Examining the relationship between the change in managerial ownership and the
change in firm’s performance (both aspects are considered as: market-based
(forward-looking) measurement and an accounting- based (backward-looking)
measurement).
1.3

Research questions
To achieve the objectives of the study, the following research questions have been

raised.
(i)

What are the determinants of optimal level of managerial ownership in
Vietnamese listed firms?

(ii)

Have managers adjusted their proportion of firm’s share toward the optimal level?
3

(iii) What factors have been considered to provide an impact on the managers’
decisions on purchasing and selling stocks?
(iv) Is there any relationship between the change in managerial ownership and the
change in firm’s performance in both aspects accounting-based and market based
measurement?
1.4

Contributions of the thesis
Several considerable and highlight contributions of this study could be found as follow:
(i)

First, a new measurement of managerial ownership (both direct and indirect
ownership) is conducted. This result created a detailed database of managerial
ownership of Vietnamese listed firms.

(ii)

Second, provided more empirical evidence about the relationship between
managerial ownership and firm’s performance with a different approach compared
to previous studies. The contemporary approach envisaged on the changes
(increase or decrease) in managerial stock ownership and the changes in firm’s
performance instead of the level of two mentioned variables like traditional
approach.

1.5

Research scope
In general, the study investigates this relation by exploiting database which consisted of

285 non-financial firms listed on HOSE in the period from 2010 to 2015. Nevertheless, in

several econometric regressions, some observations are excluded due to the inefficiently
matched data.
1.6

Structure of the thesis
Chapter1: Introduction
In this chapter, the gap of previous researches, the objectives of study, scope of study,
the motivation, and contributions of this study are presented.
Chapter 2: Literature review
The chapter reviews the existing theoretical framework, mechanism and empirical
evidences of the relationship between managerial ownership and firm’s performance.
The legal framework of corporate governance in Vietnam, as well as the measurements
of firm’s performance and managerial ownership is also clarified.
Chapter 3: Research methodology and data
This chapter exhibits the methodology, quantitative econometric models as well as
explains the measurement and definition of variables.
4


Chapter 4: Results and discussions
The statistical description, results of estimation and interpretations of the result are
discussed and compared to previous studies.
Chapter 5: Conclusions and policy implications
Some remarkable findings and proposed policy implications are presented. Limitations
and further research also could be found in this chapter.

5


Chapter 2

LITERATURE REVIEW
In this chapter, the relatively theoretical framework, mechanism of managerial
ownership and firm’s performance, together with empirical evidences around the world and
Vietnam are presented. The structure of these contents is organized as following:
(i)

The related theoretical framework helps us explain the mechanism of this
relationship;

(ii)

The empirical evidences of the relationship between managerial ownership and
firm performance around the world and Vietnam with cross-sectional or panel
data (might be found);

(iii) The corporate governance of Vietnamese listed firms.
2.1
2.1.1

The theoretical background of managerial ownership and firm’s performance.
The agency approach
Agency theory, according to Jensen and Meckling (1976) claimed that ownership

structure can effect to agency cost. They stated that there is conflict between managers
(agents) and shareholders (principals) in managing firm’s operation. Managers would be
responsible for all their decisions even though they do not serve full profit of firms. Therefore,
with the power, they could pursue the investment plans to generate benefit themselves even
these spending can be harm for all firms (shareholders). In the one hand, managerial
ownership could be one of the solutions to alleviate the conflict between agents and
principals. Lower fraction of stock held by managers could result in the lower monitor cost.

Zwiebel (1995) proposed that the monitor carried by owners could not eliminate absolutely
the harm from manager’s decision. Beyer, Czarnitzki, and Kraft (2012) proposed that
increasing level of managerial ownership will result in managers (agents) behaving like
owners (principals). It implies that principal-agent divergence would reduce when the level
managerial ownership increased up to the threshold. In the other hand, they also argued that
the managerial discretion appeared when board of directors accumulated enough power. After
that, they pursue their own benefit rather than maximizing firm value. Cosh, Fu, and Hughes
(2007) also advocated the combination of effects between innovation and entrenchment
during the increasing managerial ownership level.

6


To sum up, an increase in managerial ownership creates both countervailing interest
alignment and entrenchment effect. So, there are two opposing impacts: the incentive and
entrenchment effects of managerial ownership and firm’s performance. The effects are
provoked by the separation between principal(s) (the owners) and agent(s) (managers) when
the agents make the decision to maximize principal(s)’ welfare.
2.1.1.1

The incentive effect

Jensen and Meckling (1976) argued that managers hold stocks; they have an incentive
to adopt investment strategies that are benefit for all company by augmenting the cash flow of
firm and reducing outside payment. The higher percentage of managerial ownership was
consistent with the higher firm’s performance.
Leland and Pyle (1977) claimed that managerial ownership can also serve as a signal for
company quality. They argued that insiders own shares to maximize their welfare, so they are
also risk-averse which indicates that they consider carefully their investment opportunities.
Managers increase their percentage of shareholding to signalize more valuable firm and

outsiders are convinced that it is good investment. In addition to that, Stulz (1988) argued that
higher managerial ownership caused the lower probability of hostile takeovers.
2.1.1.2

The entrenchment effect

There is a negative relationship between managerial ownership and profitability or firm
value, especially at considerably high level of managerial ownership. The higher managerial
ownership level is, the more difficulty for outside owners control the management, so
managers could make decisions for their own benefit instead of the whole firms.
Morck, Shleifer and Vishny (1988), and Stulz (1988) argued that with higher voting
right, the appearance of entrenchment effect which indicates the higher managerial ownership
would induce the negative impact on firm’s performance. Since, it is difficult for external and
minority shareholders to monitor and control the firm.
Moreover, Hirshleifer and Thakor (1994) indicated that ineffective management has the
roots of the inefficiently valuable information getting from takeover market. Other argument
presented by Fahlenbrach and Stulz (2009), who claimed that the cost of holding more share
tends to increase since managers’ portfolio becomes less diversified. They are willing to hold
more stock when the compensation is proportional or more.
Generally, agency theory indicates that there is trade-off between advantage and
disadvantage of higher managerial ownership. So, there is a nonlinear relationship between
managerial ownership and firm’s performance and exists an optimal level of managerial
7


ownership. McConnell and Servaes (1990) predicted the inversed U-shaped relationship
between managerial ownership and firm performance in terms of market-based measurement.
They explained that at the lower level of managerial ownership, incentive effect was
outstanding the entrenchment effect. Then negative effect becomes dominated along with
increasing managerial ownership. Larcker, Randall and Itner (2003) predicted that firm’s

characteristics such as the stage in firm lifecycle, R&D expenditure, assets structure, and
growth opportunities could affect to the optimal level of managerial ownership.
The effect of managerial ownership on firm’s performance could be demonstrated as
figure1.1.
Figure 1.1

The relationship between insider ownership and firm’s performance.

Firm’s performance

INOWNS
Convergences of
interests

Entrenchment

Convergences of interests

effect

Source: Iturralde , Maseda , and Arosa (2011).

2.1.2

The managerial discretion approach
Hambrick and Finkelstein (1987) initially introduced managerial discretion theory

which defined as the latitude of managers in making strategic decision process. Three reasons
of managerial discretion were identified. Firstly, the variance of environment influences on
enterprises and managers. For example, firms with higher ratio R&D expenditure and

advertising spending would signalize for more space of managerial discretion. Another reason
is the effect of the characteristics of organization on managers’ actions. Two crucial factors
are available resources and inertial forces respectively. The initial element implies that the
inadequately financial resource would limit the manager’s strategic decision. The later factor
refers the limitation of manager’s latitude which was especially important in large
8


organization and strong corporate culture. The last factor is managers themselves. Finkelstein
and Boyd (1998) modeled the managers’ compensation and discretion and they discovered
that the higher firm’s performance would follow the higher payment of managerial discretion.
Stulz (1990) and Zwiebel (1996) developed further managerial discretion theory. They
claimed that managers will select the magnitude of ownership to maximize their utilities
instead of enterprises value. With this approach, managerial ownership is endogenous instead
of exogenous under managerial discretion theory. The cost always is consistent with managers
extracting firm’s cash flow when managers carry out for their own benefit. To extent to the
negative relationship between managerial ownership and firm’s performance are detected
since they utilized their discretion to maximize their objectives (Fama, 1980; Jensen, 1986;
Brush, Bromiley, & Hendrickx, 2000).
According to Fahlenbrach and Stulz (2008), three key motivations are explored when
managers held stock under managerial discretion approach.
The financing motivation
When enterprises exercised constrained financial resources, especially start-up firms,
managerial ownership could have cheaper cost of capital compared to other external sources.
Firms with higher information asymmetries will be limited to access other external resources
like bank loan or equity from outsider investors. When the firm becomes mature, the cost of
issuing share or bank loan reduces, so financing motivation of managers is secondary role.
Therefore, they predicted that the percentage of stock held by managers will decrease over
time.
The bonding motivation

The interest of managers and minority shareholders can align via the managerial
ownership as long as the fraction of their stock do not excess of specific threshold. The
bonding motivation is emphasized in the case managers being lower reputation or wider
managerial discretion space. When the firm operated with higher ratio intangible assets, lower
growth opportunities or managers being more well-known, the role of this motivation was
diminished. This phenomenon occurred when organizations operated stably and relatively full
grown.
The control motivation
Board of directors tends to acquire more shares when their control is threatened.
Increasing managerial ownership likely occurs when business is not performing well and the
9


ability of managers has not been widely recognized. Their action helps them convince the
owners that they will endeavor to work and reduce the probability of hostile takeovers.
In summary, with the explanation of managerial discretion approach, the increasing
managerial ownership often takes place in the younger or financially constrained firms. This
phenomenon also likely occurs in poor-performing firms or in the case of managed skills of
board of directors has been not publicly recognized. This approach also interpreted that the
managers would sell their stock when firms perform well or in the case market being more
liquid. Thanks to the managerial discretion approach, partial explanation of the action of
purchasing and selling shares of managers could achieve. So, authors can concentrate on
change in managerial ownership and change in firm’s performance instead of the level of
these measurements as vast previous studies.
2.1.3

The timing approach
The concentrated content of timing approach is that the insiders will have more

information of operation of enterprises compared to outside investors, so they could gain

abnormal return. It indicates that the managers probably purchase firm stock when the firms
performed well likely signifying the overvalued firm share and vice versa (Jenter, 2005)). The
market timing theory suggested that managers efficiently beat the market to get extraordinary
return. This approach provides the same results with the managerial discretion approach,
however, two approaches have different root. McConnell, Servaes and Lin (2008)
investigated the relation change in insider ownership and abnormal return by observing 6-day
interval return and their conclusion was change in insider ownership impacting on firm’s
performance.
2.2

Endogeneity of managerial ownership
Roberts and Whited (2013) proposed that endogeneity issue comes from the correlation

between the error term and one of explanatory variables. The first reason is omitted variables,
which correlated with the error term and independent variable. Secondly, the endogenous
variables have roots of imperfect measurement to capture one of the proxies (measurement
error). Additionally, simultaneity which indicated two variables are determined mutually also
induced endogeneity.
Demsetz and Lehn (1985) initially established assumptions that under contracting
environment, managerial ownership considered as endogenous variable because the
ownership level was influenced by the maximizing of firm value of manager’s decision.
Jensen and Meckling (1976) also claimed that ownership structure, specifically managerial
10


ownership would be one of the determinants of corporate performance, so the causality
problem has been raised.
The reason of endogeneity problem could be the existence of co-determinant of
managerial ownership and firm’s performance. Monitoring technology could be the first
element to illustrate for unobservable factors, for example. Ceteris paribus, firm with better

monitoring capability would require the lower optimal level managerial ownership to align
the benefit of managers (agents) and owners (principals). This company also serves higher
market value because potential investors believe that fewer firm’s resources will be allocated
to monitor the activities of administrators. If the proxy for quality of monitoring technology
does not include, the negative relationship between managerial ownership and market-based
performance of enterprises is probably spurious relation.
Additional example of firm heterogeneity is considered as the fraction of intangible
assets. When all things being equal, the companies that intensified intangible fixed assets
would require higher managerial ownership to limit the space of managerial discretion. To
extent the market performance measured by Tobin’s Q, for instance, while the denominator is
the book value of total assets, the numerator measures as the market value of assets. There
will be a huge gap between market value and book value of intangible assets, but the former is
likely higher than the later. Therefore, the unobserved ratio of intangible assets causes the
positively spurious relation between managerial ownership and Tobin’s Q.
Himmelberg, Hubbard, and Palia (1999) constructed the generally econometric model to
explain endogeneity of managerial ownership due to the heterogeneity of firm environment.
xit and uit denote observable and unobservable characteristics for firm i at year t. We assume
unobservable characteristics being time –invariant.
𝑚𝑖,𝑡 = 𝛽0 + 𝛽1 𝑥𝑖,𝑡 + 𝛾1 𝑢𝑖 + 𝑒𝑖,𝑡

(1)

where:


eit is white noise;



mit is the level of managerial ownership;



xit is observable characteristics;



ui is unobservable characteristics.

According to optimal contract, the manager’s effort can be represented by the following
equation:
𝑦𝑖,𝑡 = 𝜃𝑚𝑖,𝑡 + 𝛽2 𝑥𝑖,𝑡 + 𝛾2 𝑢𝑖 + 𝜖𝑖,𝑡
11

(2)


The firm’s performance of firm i at year t (PERit) is the function of managers’ effort,
observable and unobservable firm characteristics:
𝑃𝐸𝑅𝑖,𝑡 = 𝜕 𝑦𝑖,𝑡 + 𝛽3 𝑥𝑖,𝑡 + 𝛾3 𝑢𝑖 + 𝜗𝑖,𝑡

(3)

So, we can combine (2) and (3):
𝑃𝐸𝑅𝑖,𝑡 = 𝜕𝜃 𝑚𝑖,𝑡 + (𝜕𝛽2 + 𝛽3 ) 𝑥𝑖,𝑡 + (𝜕𝛾2 + 𝛾3 )𝑢𝑖 + 𝜕𝜖𝑖,𝑡 + 𝜗𝑖,𝑡

(3a)

The short version of equation (3a)
𝑃𝐸𝑅𝑖,𝑡 = 𝛼0 + 𝛼1 𝑚𝑖,𝑡 + 𝛼2 𝑥𝑖,𝑡 + 𝜏𝑖,𝑡

(3b)

If we use equation (3b) to test the relationship between managerial ownership and
firm’s performance, the parameters (or only one of parameter) are (is) consistent as long as
the error term 𝜏it in the equation (3b) is uncorrelated with managerial ownership (independent
variable) and firm’s performance (dependent variable). Nevertheless, the level of managerial
ownership depends on unobservable characteristics, so 𝜏it is correlated with managerial
ownership (m).
In term of econometrics, the result could be:
𝐸 (𝑚𝑖,𝑡 , 𝜏𝑖,𝑡 ) = 𝐸 ((𝛽1 𝑥𝑖,𝑡 + 𝛾1 𝑢𝑖 ) (𝜕𝛾2 + 𝛾3 )𝑢𝑖 ) = 𝛾1 (𝜕𝛾2 + 𝛾3 )𝛿𝑢2

(4)

As a result, we cannot estimate equation (3b) by OLS because the coefficients are
inconsistent and biased. So, the research focused on the change instead of level of managerial
ownership.
2.3

The empirical evidences of relationship between managerial ownership and firm’s
performance and limitations

2.3.1

The research in worldwide and the limitations

2.3.1.1

The exogenous managerial ownership

There are vast number of empirical studies investigated the relationship between
managerial ownership and firm’s performance using cross-sectional data, and these researches
showed different shapes of the relationship. However, general conclusion could be that
relationship between firm’s performance and managerial ownership is nonlinear.
Morck et al. (1988) examined the relationship between managerial ownership and
Tobin’s Q with cross-sectional data of 500 Fortune firms which were likely large-scale
enterprises and operating stably. They explored the threshold of managerial ownership
fluctuating from zero percent up to 5 percent which provided positive effect on Tobin’s Q is
one of proxies for firm’s performance in terms market-based measurement. Then, the Tobin’s
Q would reduce if managerial ownership increases up to 25 percent and the repeatedly
12


positive impact again in the case managers owned 25 percent excessively. The nonlinear
relationship is illustrated similarly Figure 2.1.
By observing 1,173 enterprises listed on NYSE and AMEX in two separated year 1976
and 1986, McConnell and Servaes (1990) found the reversed U-shaped relationship between
Tobin’s Q and insider ownership level. Managerial ownership provided positive effect on
firm’s performance with threshold up to approximately 40 percent to 50 percent. They
investigated the relationship between Tobin’s Q (dependent variable) and two control
variables, namely the fraction of insider ownership and its square. The coefficient of the
former was significantly positive and the negative coefficient of its square also was found so
it confirmed such non-monotonic relation.
Short and Keasey (1999) strengthened the mentioned argument by providing more
empirical evidence in United Kingdom. They employed two proxies of firm’s performance
that are the ratio market of total assets over the book value of equity (VAL) and return on
equity (ROE) regressed against a cubic function of level of managerial ownership. To the
extent market-based measurement, VAL fluctuated with the shape of relation likely the result
of Morck et al. (1988). Nevertheless, managerial ownership (percentage) thresholds varied
distinctively. More specifically, the first positive threshold is 12.99 percent. Then, the

negative relation took place until the managerial ownership reaching 41.99 percent-threshold
while the positive impact would recover. In terms of accounting-based measurement such as
ROE, the same correlated graph with VAL was explored with diverse turning points which
were 15.58 percent and 41.84 percent, respectively.
Kole (1995) conducted experiments of 352 firms instead of 500 Fortune firms like study
of Morck et al. (1988) and explored that N-shaped relationship between level of managerial
ownership and Tobin’s Q, but the turning points considerably altered. The positive effect of
managerial ownership on Tobin’s Q is more significantly sustained in small firm than large
firm.
Hermalin and Weisbach (1991) analysed the triennial data of 142 firms listed on NYSE
in 1971, 1974, 1977, 1980 and 1983 in the order and the inversed W-shaped relation between
managerial ownership and Tobin’s Q had been found. To be specific, the beginning is positive
relation of managerial ownership up to 1 percent, thereafter this relationship reverses when
managerial ownership fluctuates in the scope from 1 percent to 5 percent. When managerial
ownership continues increase excess of 5 percent, positive effect accounts a dominant
13


position, and this effect is simply replaced by a negative impact with the 20 percentage threshold of managerial ownership.
To sum up, most of the results have shown that the relationship between managerial
ownership, or insider ownership and firm’s performance is non-monotonic. The mentioned
empirical evidences are characterized by assumption of managerial ownership being
exogenous and utilizing cross-sectional data only. So, the limitation of these empirical
evidences is impossible to control adequately for unobservable firm heterogeneity that means
change in firm’s environment.
2.3.1.2

The endogenous managerial ownership

As mentioned in the previous section, Demsetz and Lehn (1985) provided some

arguments that under contracting environment, the importance of unobserved heterogeneity
need to be emphasized. Himmelberg, Hubbard, and Palia (1999) investigated the relationship
between managerial ownership and firm’s performance with panel data including 600 US
firms at random from 1982 to 1992 period which took endogeneity issue into consideration.
They employed fixed effect model to estimate the relationship between the fraction insider
ownership and firm value. The result of study showed that no econometrically significant
impact and regression results in previous studies probably reflect the spurious (or false)
relation.
The endogenous managerial ownership has been approved by vast number of
researchers and some econometric solutions to overcome this issue have been conducted.
Notwithstanding, the explanation of estimated results that the change in managerial ownership
has been taken advantage to change firm value provoked the controversy.
The first mentioned remedy is to use panel data and fixed effects. Fixed effect can
accommodate unobserved heterogeneity when the authors assume unobserved heterogeneity
being time-invariant. The disadvantage of this method is that it could be inefficient to
eliminate the spurious relationship between managerial ownership and firm’s performance
absolutely since the FE model insinuatingly assumed that the omitted variables are timeinvariant. The limitation of fixed effect argued by Zhou (2001), since he observed and found
that very small and slow changes of managerial ownership in fiscal year accompanied with
dramatically change in firm value, especially Tobin's Q. He also stated that it is difficult to
explain the relationship between two subjects, because power of these tests is less effective. In
essence, Holderness, Kroszner and Sheehan (1998) summarized and proposed that the level of
managerial ownership of firms listed on NYSE and AMEX had change from time to time.
14