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Share ownership by execs, directors, or institutions Has little effect on corporate performance, study finds

January 1, 2003

For more information, contact: Benjamin Haimowitz,

Putting so much emphasis on making top execs owners is a lazy approach"

With all the debate that has raged over executive stock options and their potential for good and ill, one crucial question seems all but forgotten:

How much difference does equity ownership by executives actually make in boosting company performance?

A study in the February/March 2003 issue of the Academy of Management Journal comes up with a surprising answer: By itself, little or none.

Based on an immense amount of data, the new research, which was first presented at last summer's annual meeting of the Academy of Management, focuses on changes in equity ownership widely believed to promote good corporate governance through two means: 1) increased financial stakes of executives and board members in the companies they manage, and 2) concentrated shareholdings among institutional investors and blockholders, who have the resources to closely monitor top company management.

That these factors have made little or no difference in companies' financial performance emerges from a meta-analysis of 229 management studies from 1971 to 2001, including 126 published since 1995. Meta-analysis is a technique that permits many studies to be combined to give overall results reflecting a vast amount of data.

The 229 studies included in the meta-analysis focus on the largest companies in the U.S. -- that is, firms in either the Fortune 500, Forbes 500, or S&P 500.While many of the studies found a statistically significant correlation between various forms of equity ownership and company financial performance, the effect was quite small in almost every case, and the overall effect was negligible.

The article is entitled: "Meta-analysis of financial performance and equity: fusion or confusion?"

What the meta-analysis establishes -- and what the events of the past year seem to have confirmed dramatically -- are basic flaws in ideas about equity ownership that have become conventional wisdom in the business world over the past several decades. These ideas grew out of concerns, articulated as early as the 1930s, that dispersal of corporate ownership had shifted control of companies from owners to managers. The torpid performance of large U.S. corporations in the late 1970s fueled dissatisfaction among investors, who began to demand that executives and board members own significant amounts of company stock. At the very least, they looked to institutional investors and other large shareholders to enforce good corporate governance.

"Putting so much emphasis on making top managers owners is a lazy approach," says Indiana University's Catherine M. Daily, a co-author of the new study with Dan R. Dalton and Rungpen Roengpitya of Indiana and S. Trevis Certo of Texas A&M. "It takes just one element of many that may contribute to successful company management -- that is, alignment of financial interests between top executives and shareholders -- and makes it practically into the be-all and end-all. There has also been a tendency to put too much faith in institutional investors: expecting them to lead the charge is asking more of them than they're equipped to do."

The study analyzes the relationship of eight different categories of ownership to each of 14 measures of firm performance. The categories of ownership are CEO equity, board equity, officer and director equity, inside board equity, outside board equity, management equity, institutional equity, and blockholder equity.

Indicators of firm financial performance include return on assets, return on equity, shareholder returns, earnings per share, market-to-book ratio, price-earnings ratio, and a measure called Tobin's Q, the market value of a company's assets divided by their replacement value.

In all, the authors found 1,880 relationships in the 229 studies, with each relationship based on data from hundreds of firms.

Their conclusion: "There is little evidence for systematic relationships between equity and financial performance."

"The only relationships of even marginal consequence involved earnings per share," they add, a measure "somewhat more subject to manipulation" than other indicators.

If patterns of equity ownership don't throw light on corporate performance, what does? An earlier meta-analysis by some of the same researchers found little explanatory power in other staples of corporate reform, such as staffing company boards with a high proportion of outsiders or having someone other than the CEO as board chairman.

Corporate management, the authors suggest, is too complex for single factors to result in uniform consequences, whether for good or ill. More likely they produce effects that depend on a variety of other factors.

For example, separating the position of board chairman from that of chief executive can make good sense, they note, when there is a sizable risk of CEO entrenchment, as when the CEO has strong informal power or when firm performance is good. But in other circumstances combining the positions can foster strong leadership that gives a boost to company performance.

Or, to cite another example, the effect of a sizable CEO ownership stake can vary considerably depending on the equity held by other blockholders. "CEOs with a five-percent equity position on their firms might behave very differently depending on whether other blockholders hold, for example, five percent or 50 percent of the remaining equity."

In the end, says Daily, achieving management accountability depends on a lot more than applying simple rules. "Boards of directors may be more active than they once were," she concludes, "but, in general, they still have a long way to go.

"The Academy of Management Journal, a peer-reviewed publication now in its 46th year, is published every other month by the academy, an organization with more than 12,000 members in 60 countries that seeks to foster the advancement of research, education, and practice in the management field. The Academy's other publications are the Academy of Management Review, the Academy of Management Executive, and the Academy of Management Learning and Education.

Media Coverage:
The Indianapolis Star. Kelley study debunks corporate governance theory. (Thursday, January 30, 2003).
The New York Times. Options do not raise performance, study finds. (Sunday, August 11, 2002).
The New York Times. What's fair pay for running the family store?. (Sunday, January 12, 2003).
USA Today. CEO pay takes another hit. (Monday, March 10, 2003).

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