Causes and consequences of external blockholdings

This dissertation seeks to investigate empirically the determinants and implications of large block shareholdings. Specifically, it attempts to answer the following questions : (1) Why do some firms have blocks and others not ? (2) What are the valuation consequences of large block creations ? (3) What are the cross-sectional relationships between the market response and characteristics of the firm and of the blockholder ? and, finally, (4) What are the time series (and control-firm-adjusted) changes in firm performance measures and operating variables attributable to large shareholder monitoring ? The above questions are addressed by recognizing, firstly, that the incidence of large block shareholdings is rational only when the gains from a blockholding exceed the costs of foregone diversification-of-portfolio opportunities. The potential sources of gains to the blockholder are identified as resulting from firm-value-increasing reductions in the agency costs of free cash flow and other non-free-cash-flow-related equity agency costs, equity-value-increasing potential for wealth transfers from bondholders, firm-value-increasing expectation of synergy gains in the case of corporate blockholdings, as well as equity-value-reducing gains such as the potential for insider trading, and the expectation of a greenmail premium. It is hypothesized that the net valuation impact of these gains to the blockholder is positive. Event study results support this hypothesis. Cross-sectional regression results suggest that announcement period abnormal returns are reliably explained by the potential for wealth transfers from bondholders, as proxied by the level of discretionary assets in the firm. Further, consistent with theory, announcement excess returns are positively related to the size of the blockholding and the identity of the blockholder. There is no evidence that blockholders play a valuable role in limiting managerial discretion over free cash flow. Firm-specific risk also appears to have no valuation impact; this suggests that the potential benefits from blockholder monitoring may be offset by the potential costs resulting from insider trading. Finally, a pre- and post-block matched-pair comparison of key performance measures and operating variables between the sets of sample firms and control firms provides weak support for the monitoring role of the large block shareholder. A time-series tracing of blockholder affiliation with the target firms reveals that in only a small fraction of firms does the blockholder obtain a seat on the target firm’s board of directors - a virtual requirement for effective monitoring to occur. Overall, these findings do not support theoretical arguments that envisage blockholder monitoring as a long-term incentive-alignment mechanism between managers and shareholders.