Diploma Thesis, 2003, 102 Pages
List of Figures
List of Tables
List of Abbreviations
List of Symbols
1.1 Problem and Objective of the Thesis
1.2 Organization of the Thesis
2 The Relationship Between Capital Structure, Management Ownership and External Block Holders – Prior Research and Hypotheses
2.1 Capital Structure and Management Ownership
2.1.1 Incentive-Alignment Hypothesis
2.1.2 Signaling and Corporate Control Considerations
2.1.3 Management Entrenchment Hypothesis
2.1.4 Non-Linearity and Hypothesis Development
2.2 Capital Structure and External Block Holders
2.3 Interaction of Management Ownership and External Block Holders
3 Econometric Analysis of Ownership and Capital Structure
3.1 Data and Model Specification
3.1.1 Sample Selection
3.1.2 Ownership Structure Variables
3.1.3 Measures of Capital Structure and Univariate Analysis
3.1.4 Additional Capital Structure Determinants
3.1.5 Variable Overview and Correlation Analysis
3.1.6 Multivariate Regression Models
3.2 Empirical Results and Theoretical Implications
3.2.1 Capital Structure and Management Ownership
3.2.2 Capital Structure and External Block Holders
3.2.3 Interaction of Management Ownership and External Block Holders
3.3 Robustness of Results
3.3.1 Multicollinearity, Heteroskedasticity and Non-Normality
3.3.2 Alternative Variable Definitions
3.3.3 Exclusion of Observations
4.1 Summary and Critique
4.2 Implications for Further Research
Fig. 1: Total agency costs as a function of outside equity and debt
Fig. 2: Agency costs for two different scales of outside financing
Table 1: Overview of Evidence on Managerial Ownership and Debt Ratios
Table 2: Overview of Evidence on External Block Holders and Debt Ratios
Table 3: Sample Selection Process
Table 4: Descriptive Statistics on Ownership Structures
Table 5: Univariate Analysis of Ownership Structure and Capital Structure
Table 6: Descriptive Statistics on Regression Variables
Table 7: Correlation Analysis of Regression Variables
Table 8: Regression Results of Management Ownership Models
Table 9: Regression Results of External Block Ownership Models
Table 10: Regression Results of Interaction Models
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The idea that the general characteristics of a firm’s ownership structure can affect performance has achieved considerable attention, and related research brought forward relatively consistent empirical evidence, e.g. on the positive impact of managerial ownership on firm performance. However, the evidence on the relation between ownership and capital structure is less consistent and numerous, although there are good reasons to believe that there may be such a relationship.
Since the capital structure irrelevance propositions of Modigliani/Miller (MM) economists have devoted considerable time to studying cross-sectional and time-series variations in capital structure. More recent work following the seminal contribution by Jensen/Meckling has employed an agency theory perspective in the search for an explanation of capital structure variations. With this managerial perspective capital structure is not only explained by variations in internal and external contextual factors of the firm, but also by the values, goals, preferences and desires of managers. Corporate financing decisions are influenced by managers’ incentives, and the incentives for managers to act opportunistically can be influenced by the ownership structure of the firm.
However, most empirical work analyzing a firm’s capital structure in cross-sectional and time-series studies ignores the equity ownership structure as a possible explanatory variable. This can be partly explained by problems associated with the availability of ownership data, when compared to readily available accounting and market data on other relevant variables. Not withstanding, it entails a problem of model misspecification as omitting a relevant variable may cause misleading empirical conclusions. Additionally, the problem arises that the studies taking ownership structure into account do not bring forward consistent results. They find contradictory evidence without any side clearly dominating the discussion, neither theoretically nor empirically.
The objective of this thesis is to contribute to the empirical debate of those two problems by investigating whether the structure of equity ownership can help in explaining cross-sectional variation in capital structure for the case of Germany. Since corporate managers and external block holders are two groups who have considerable influence on a firm’s decisions, this thesis focuses on the effects of managerial share ownership and external block ownership on capital structure.
Moreover, despite the widespread interest in the firm’s financing decisions, most of capital structure research has been conducted in the United States (US). As such, there is no German evidence on the link between ownership structure and capital structure, Therefore, the empirical analysis of this thesis focuses on Germany by examining companies listed on the Frankfurt stock exchange and part of the share indices Deutscher Aktienindex (DAX), Mid-cap DAX (MDAX) and Small-cap DAX (SDAX).
In order to accomplish this objective the thesis is divided into two main sections, specifically a discussion of the theoretical contributions in chapter 2 and the empirical analysis using a multivariate regression approach in chapter 3.
Chapter 2 builds the theoretical ground of this thesis and develops explicit hypotheses to be tested in chapter 3. Firstly, the basic theoretical pillars of the link between management ownership and capital structure are introduced in chapter 2.1 by presenting the incentive-alignment hypothesis, corporate control considerations and the management entrenchment hypothesis as well as empirical evidence from prior research. The theories are then joined to develop two hypotheses on the relation between management ownership and capital structure (H1 and H2). Secondly, chapter 2.2 introduces theory and evidence relating the influence of external block holders to the capital structure choice of the firm. This chapter also serves to develop two hypotheses on the influence of external block holders on the firm’s capital structure (H3 and H4). Thirdly, chapter 2.3 brings together the discussion of the two prior chapters in presenting the interaction between managerial shareholdings and external block holders and developing a hypothesis regarding the effects of this interaction on capital structure (H5).
Chapter 3 contains the empirical body of this paper testing the hypotheses developed in chapter 2 with a cross-sectional multivariate regression approach on data from German companies. Chapter 3.1 describes the data set and specifies the econometric model. Firstly, a description of the sample selection process introduces the data. Secondly, some descriptive statistics on ownership and capital structure measures for the 95 firms in the sample are presented. The statistics are accompanied by simple univariate analyses tests to perform a preliminary screening for systematic differences between firms. Thirdly, theoretically and empirically proven proxies for firm-specific attributes are introduced to be able to control for other determinants of capital structure. Subsequently, the control variables are joined with the ownership structure variables to develop several multivariate regression models designed to formally test the hypotheses advanced in chapter 2.
Chapter 3.2 discusses the empirical results from the multivariate regression models developed in chapter 3.1. It separately examines the five hypotheses advanced in chapter 2 and their empirical support by the regression results. Theoretical implications are outlined in order to put into perspective the empirical significance and economic consequences of the results, as well as explain complementarities and differences to prior research. Specific consideration is given to the German institutional background in explaining the results, as this thesis is one of the few empirical studies on non-US data.
In order to validate the results of the empirical analysis Chapter 3.3 presents several robustness tests for the regression specification. This sensitivity analysis addresses possible concerns about multicollinearity, heteroskedasticity, non-normality, alternative variable definitions and discretely different observations.
Finally, chapter 4 contains a short summary of the thesis’ main hypotheses and its empirical results. Additionally, conclusions are drawn following the analysis presented in this thesis, and promising areas of future research on ownership structure are outlined to conclude the discussion.
Berle/Means argued over 70 years ago that the modern corporation is characterized by a separation of ownership and control. Since then a large body of theoretical and empirical literature has developed analyzing the effects of ownership and control on the firms operations. A considerable part of this literature concerns theories and evidence on the relationship between ownership structure and capital structure, especially the role of managerial ownership and external block holders on the leverage decision of the firm. Those two are discussed in detail in the following chapters.
In their seminal paper on agency theory Jensen/Meckling proposed that the separation of ownership and control allows managers, the agents, to consume the firm’s resources to their own personal benefit and to the detriment of external shareholders, the principals. Nevertheless, those principal-agent conflicts can be mitigated by internal and external constraints reducing management discretion. Specifically, the incentive structure of management is significantly influenced by managerial equity ownership.
Managerial equity ownership is argued to align shareholders incentives with those of external shareholders, reducing the incentives to consume perquisites (hence incentive-alignment hypothesis). Jensen/Meckling derive in their model an optimum level of debt which minimizes total agency costs by balancing the agency costs of external equity and the agency costs of debt. Following this rationale, the relationship between capital structure and management ownership depends on the relative size of the agency costs of equity and debt at varying levels of management ownership.
The following discussion is based on Short/Keasey/Duxbury’s excellent description of the dynamics of Jensen/Meckling’s model considering the relationship between debt and managerial equity ownership. The model by Jensen/Meckling has three main variables, management equity ownership Abbildung in dieser Leseprobe nicht enthalten, outside equity ownership Abbildung in dieser Leseprobe nicht enthalten, and external debt Abbildung in dieser Leseprobe nicht enthalten. For a specified level of external finance Abbildung in dieser Leseprobe nicht enthalten the optimal fraction of outside equity is given by Abbildung in dieser Leseprobe nicht enthalten, where Abbildung in dieser Leseprobe nicht enthalten minimizes the total agency costs Abbildung in dieser Leseprobe nicht enthalten incurred by external financing. The total agency costs are made up of the agency costs of outside equity Abbildung in dieser Leseprobe nicht enthalten and the agency costs of debt Abbildung in dieser Leseprobe nicht enthalten, such that Abbildung in dieser Leseprobe nicht enthalten. This relationship is depicted in figure 1, showing Abbildung in dieser Leseprobe nicht enthalten as an increasing function and Abbildung in dieser Leseprobe nicht enthalten as a decreasing function of Abbildung in dieser Leseprobe nicht enthalten. The optimal ownership structure is determined by the minimum total agency costs of external financingAbbildung in dieser Leseprobe nicht enthalten.
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Fig. 1 : Total agency costs as a function of outside equity and debt
Source: Jensen/Meckling (1976), p. 344.
Jensen/Meckling additionally incorporate the scale of outside financing by defining an index Abbildung in dieser Leseprobe nicht enthalten for the amount of external financing, where Abbildung in dieser Leseprobe nicht enthalten is the scale of the firm. With an increase in the amount of outside financing, management ownership of equity Abbildung in dieser Leseprobe nicht enthalten must decrease, ceteris paribus. Figure 2 illustrates that as Abbildung in dieser Leseprobe nicht enthalten increases from Abbildung in dieser Leseprobe nicht enthalten to Abbildung in dieser Leseprobe nicht enthalten the optimal level of outside equity increases, i.e. Abbildung in dieser Leseprobe nicht enthalten.
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Fig. 2 : Agency costs for two different scales of outside financing
Source: Jensen/Meckling (1976), p. 347.
Reversing this argument Short/Keasey/Duxbury conclude that “[a]s Abbildung in dieser Leseprobe nicht enthalten decreases the level of [outside] equity finance must therefore fall, which is equivalent to saying that as management ownership Abbildung in dieser Leseprobe nicht enthalten increases the level of debt Abbildung in dieser Leseprobe nicht enthalten in the optimal ownership structure increases.” As a consequence it is plausible from an agency theoretic perspective to deduce a positive relationship between management ownership and debt given the agency cost functions presented.
However, Jensen/Meckling acknowledge in a caveat that the exact shape of the functions of the agency costs of debt and external equity are open to question. Therefore, also the functional shape of the total agency costs of outside financing “is a question of fact and can only be settled by empirical evidence”.
Additionally, besides arguing via the relative size of the agency costs of equity and debt at different management ownership levels, there are several other arguments advanced proposing a positive relationship between managerial ownership and leverage. Management behavior, which is influenced by managerial preferences and especially managerial risk aversion, plays a key role in further considerations of the agency costs of debt. When risky debt is outstanding equity has a convex payoff structure such that shareholders gain by shifting into higher risk projects. Such risk shifting, also called asset substitution, increases the agency costs of debt. This gain to shareholders by risk-shifting is clarified by viewing equity as a call option on the firm’s assets with an exercise price equal to the face value of debt. An increase in the risk of the underlying assets raises the option value, thereby increasing the value of equity and decreasing the value of debt. As bondholders foresee this risk shifting behavior, they incorporate it into bond yields, such that shareholders bear the increase in the agency costs of debt as an increase in the cost of debt capital. However, as managerial ownership increases and managers’ stake in the firm becomes increasingly concentrated, increased risk aversion by managers due to limited diversification may reduce their incentive’s to follow such risk shifting behavior. As a consequence, management’s interests may be more closely aligned with creditor’s interests reducing the agency costs of debt. This represents therefore another argument for a positive relationship between management ownership and debt ratios.
In a similar line of thought Kim/Sorensen propose that high management ownership is characterized by lower agency costs of debt, as debtholders may believe that negotiations with insiders reduce sub-optimal investment cost. Furthermore, they hypothesize that the standard debt covenants can be considered more effective for closely held firms, decreasing risk shifting opportunities and therefore the agency costs of debt. Hence, they also advance the hypothesis of a positive relationship between management ownership and leverage.
Partly confirming the arguments presented above a recent empirical study has shown that family firms, per definitionem firms with relatively high managerial ownership, enjoy a lower cost of debt as compared to dispersedly held firms. The difference of 32 basis points is quite significant, implying a strong case for higher debt ratios in family firms which face lower agency costs of debt.
In addition to that, there are several empirical studies directly confirming the incentive-alignment hypothesis by documenting a significant positive relationship between debt ratios and managerial ownership for US firms. The econometrical approaches employed by those studies are predominantly cross-sectional multivariate regressions as employed in this thesis. Nevertheless, one study uses a probit model examining the choice of the method of payment for acquisitions, and another one an analysis of changes in leverage after acquisitions and divestitures using difference-in-mean tests.
Besides the US studies Short/Keasey/Duxbury is the only study on another country, namely the United Kingdom (UK), supporting a linearly positive relationship between debt ratios and management ownership. It is therefore given special consideration in the discussion of the results in chapter 3.2.
In the following two other theoretical predictions of a positive relationship between management ownership and debt ratios are presented: (1) a signaling model by Leland/ Pyle, and (2) corporate control considerations put forward by Harris/Raviv and Stulz.
In their seminal paper Leland/Pyle developed a model of asymmetric information which predicts that firms with a larger fraction of equity owned by management have higher debt ratios. The basic idea is that increases in firm leverage allow managers to retain a larger fraction of equity. The higher equity ownership reduces management’s welfare due to risk aversion, but the decrease is smaller for managers of high quality firms. Therefore, managers of high quality firms can signal this fact by having more debt in equilibrium. Based on this notion, Leland/Pyle develop an equilibrium in which debt increases with management ownership signaling firm quality to outside investors. Their model therefore predicts a positive relationship between management ownership and debt ratios.
An additional explanation for such a relationship is advanced by Harris/Raviv as well as Stulz centering on managers’ incentives to maintain control over the corporation. Specifically, by issuing debt and using the proceeds to retire equity held by the public, owner-managers decrease the fraction of votes held by outside investors, therefore increasing the probability of maintaining control and reaping the concomitant benefits. Stulz additionally points out that higher leverage may deter raiders because of increasingly restrictive covenants associated with higher debt ratios and the decreasing ability to issue more debt. Hence, financing investments by debt or from internal sources rather than by issuing new equity increases owner-managers’ control over the firm, thereby serving as a takeover resistance strategy.
However, the apparent incentives of owner-managers to increase debt in order to increase their control over the firm need to be interpreted carefully. Stulz points out that, since an exchange of equity for debt reduces the market capitalization of the firm, it may become cheaper for a raider who faces increasing marginal costs of borrowing to acquire equity and replace management. Harris/Raviv argue that increasing debt might also decrease the possibility of maintaining control due to the increase in bankruptcy risk, the increased restrictiveness of debt covenants, and the greater commitment to future cash payments. Therefore, the relation between leverage and control is not unambiguous and warrants empirical examination. An empirical study by Amihud/Lev/Travlos examining the method of payment for acquisitions confirms the predictions by finding a positive relationship between management ownership and cash (raised by debt issues) as payment method. Overall, the models by Harris/Raviv as well as Stulz can be seen as an additional theoretical basis for the hypothesis of a positive relationship between management ownership and debt ratios.
However, despite the wealth of theoretical models and empirical evidence supporting this hypothesis, the question is not unambiguous. There is also theoretical reason as well as empirical proof opposing the hypotheses advanced in this and the preceding chapter, by arguing for a negative relationship between debt ratios and management ownership. This discussion is presented in the next chapter.
From an agency theoretic point of view debt can be seen as an internal control mechanism able to reduce the perquisite consumption of managers. Jensen argues that high levels of debt act as a disciplining device by reducing the amount of free cash flow available to the discretion of management. Along a similar line Ross and Grossman/Hart argue that managers may use debt as a signaling mechanism to pre-commit themselves to meeting debt obligations, such as regular interest payments. Thereby, they reduce their discretionary control over the firm’s cash flow and the incentives to engage in non-optimal activities.
Managerial equity ownership can also be seen as a disciplining mechanism aligning the incentives of management and external shareholders as explained in chap. 2.1.1. Therefore, some authors propose a substitutional relationship of those two alternatives to controlling agency costs. Hence, an increase in management ownership, which reduces the agency costs associated with the separation of ownership from control, should reduce the need for high debt levels as a disciplining device for management. This argument proposes a negative relationship between management ownership and leverage.
Furthermore, managers face high levels of unsystematic risk due to their non-diversifiable human capital invested in the firm. Therefore, they have incentives to reduce their non-diversifiable employment risk by ensuring the continued viability of the firm. Non-diversifiable risk is additionally increased with the amount of management’s investments in the firm. Managers can be expected to have a limited amount of personal wealth, which effectively decreases their diversification with any increases of their ownership stake. They may not be able to invest in a well-diversified portfolio to minimize portfolio risk, therefore incurring a welfare reduction due to their relative under-diversification. Thus management would be expected to become more and more risk averse with increasing ownership in the firm. This additional risk aversion is hypothesized to provide greater incentives to reduce the level of debt and therefore the probability of bankruptcy. Since bankruptcy or financial distress will probably result in a loss of employment, damages to management reputation as well as lower future earnings, it is argued that managers have incentives to reduce debt to sub-optimal levels. This argument is in principle along the same lines concerning risk aversion as outlined in chapter 2.1.1. However, it reaches a different conclusion regarding the consequences of increased managerial risk aversion in proposing a direct negative relationship between management ownership and leverage.
This hypothesis is called the management entrenchment hypothesis, as it also contends that with increasing management ownership managers’ discretion over the debt policy of the firm increases. This provides not only greater desire but also greater ability to adjust the debt ratio downwards to suit management’s own interests. Therefore, managers are seen as more and more entrenched with increasing ownership of the firm.
There are several empirical studies on US data confirming the management entrenchment hypothesis by demonstrating a significant negative relationship between management ownership and debt ratios. This explicitly contradicts the results of the studies supporting the incentive-alignment hypothesis and corporate control considerations cited in the prior chapters. However, there are several differences between the studies which may explain the conflicting results.
The two earliest studies by Friend/Lang and Friend/Hasbrouck use the market value of insider shareholdings as main independent variable, as they follow the managerial risk aversion hypothesis and prove this variable to be the best proxy for undiversified managerial risk. They find a significant negative relationship between the market value of insider shareholdings and leverage. However, the fraction of insider shareholdings, a variable more commonly used in other studies, is insignificant and in some model specifications even positively related to debt ratios. Additionally, their ownership data set is different and subject to criticism as pointed out by Mehran. Nevertheless, this criticism can be partly alleviated by the findings of Firth, who uses similar explanatory variables as Friend/Land and Friend/Hasbrouck on a different data set. Firth confirms their earlier results by finding a negative relationship between insider shareholdings and leverage.
The studies by Jensen/Solberg/Zorn as well as Bathala/Moon/Rao use an econometrically different approach as the other studies by employing simultaneous-equations frameworks instead of single equation regressions. This approach is designed to deal with the possibility of the endogeneity of managerial ownership in regard to the leverage decision. However, when Bathala/Moon/Rao employ a single equation regression approach using ordinary least squares (OLS) as in most other studies, the relationship between management ownership and debt ratios becomes insignificant. This result points to possible endogeneity problems in the single equation regression approach employed in this thesis.
Finally, the study by Moh’d/Perry/Rimbey also employs a different econometrical approach as it not only examines cross-sectional data, but looks at a period of 18 years using a pooled time-series cross-sectional OLS regression. However, it also demonstrates a negative relationship between insider ownership and debt ratios for the cross-sectional and time-series regressions alone, although with less significance.
Therefore, in view of this evidence as well as the evidence presented in the prior chapters confirming the incentive-alignment hypothesis and corporate control considerations, the question of the relationship between management ownership and debt ratios seems to be empirically as well as theoretically unresolved.
The discussion is taken up in a recent empirical study by Brailsford/Oliver/Pua on Australian firms. They hypothesize that the conflicting evidence may be explained by dropping the assumption of linearity in the relationship between management ownership and capital structure. Following the findings of the ownership-performance literature they propose a non-linear inverted U-shape as a potential function explaining the relationship between management ownership and capital structure. At low levels of managerial equity ownership the incentive-alignment effect is hypothesized to lead to lower agency costs of debt and increasing debt ratios. However, with increasing management ownership the entrenchment effect occurs at some point, increasing the incentives for managerial opportunism due to the large exposure to firm risk. Therefore, the relationship between management ownership and debt ratios is proposed to be a non-linear inverted U-shape with a positive relationship at low levels of management ownership and a negative relationship after a certain turning point.
Brailsford/Oliver/Pua are able to prove this hypothesis for their sample of Australian firms by finding a significantly positive coefficient for a linear management ownership variable as well as a significantly negative coefficient for a squared term of the management ownership variable. The turning point of the relationship is estimated to lie at a level of 49 percent managerial share ownership..
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Table 1 : Overview of Evidence on Management Ownership and Capital Structure
Source: Own Table
Table 1 reports an overview of all the empirical studies, which provide evidence on the link between managerial share ownership and leverage. From this overview it is possible to conclude, that the primarily US-based evidence is not able to clearly support either the incentive-alignment or the management entrenchment hypothesis. Seven studies find a positive relationship and seven studies find a negative relationship between management ownership and debt ratios. Two studies predicts a non-linear relation as an explanation of the conflicting findings. Furthermore, only the two most recent studies provide evidence on non-US data.
Furthermore, agency theory appears to be able to explain both phenomena depending on the crucial assumption about the impact of management ownership on the agency costs of equity and debt. Therefore, a clear theoretical prediction is missing as well. However, it may be argued that the incentive-alignment hypothesis is more rigorously based on the agency theoretic model of Jensen/Meckling, especially considering the discussion of the relative agency costs of equity and debt at different management ownership levels. Therefore, this study follows the incentive-alignment hypothesis in proposing a positive relationship between management ownership and leverage.
H1: There is a positive relationship between management ownership and debt ratios.
However, the arguments of the management entrenchment hypothesis have to be taken into account. Therefore, this thesis follows the approach of Brailsford/Oliver/Pua in additionally examining the data set for a non-linear relationship between management ownership and leverage.
H2: There may be a non-linear relationship between management ownership and debt ratios, reversing the effect from positive to negative after a certain turning point.
These two hypotheses will be empirically tested in chapter 3 with a data set of German listed companies. However, the literature on the relationship between ownership structure and capital structure considers not only management ownership, but also the influence of external shareholders on the leverage decision of the firm. This is discussed in the next chapter.
Regarding external shareholders there are generally two groups commonly hypothesized as possibly having an effect on a firm’s leverage decision: institutional shareholders and external block holders. However, those two groups are not mutually exclusive as institutional investors may also hold large blocks in listed companies. Therefore, most empirical studies focus on either one of the two and their influence on capital structure. The influence of external block holders on firms may be expected to be relatively high in Germany due to the number and the size of block holdings. Consequently, this thesis focuses on the role of external block holders (including institutional block holders) in the leverage decision of the firm.
Several authors have suggested that institutional as well as other large shareholders have incentives to actively monitor and control management decisions. Stiglitz argues that individual shareholders with relatively small holdings do not have incentives to collect the information to enable them to monitor and control the behavior of managers. This is due to a free rider problem, as any gains accruing to the individual as a result of the monitoring activity also accrue to other shareholders. However, shareholders owning a block of shares in a firm, e.g. more than 5 percent, may have the incentives necessary to effectively monitor and control management, thereby reducing their discretionary control over the firms resources. Shleifer/Vishny develop a formal model showing a large minority shareholder to be a partial solution to the free rider problem (active monitoring hypothesis).
However, Pound suggests that this is not necessarily the case as institutional investors and other block owners might be in strategic alignment with management or face conflicts of interests due to business relationships with the company (passive voting hypothesis). Additionally, external block holders still face the free rider problem so that it is sometimes argued that selling the block in a liquid market may appear as an alternative to active monitoring. Maug, however, concludes that an active and liquid market for large blocks of shares even enhances governance exercised by block holders. Therefore, this question can only be settled empirically.
Supposing external block holders were actively monitoring management, the effect of their presence on debt ratios would depend on whether the discipline exerted by them acts complementary or substitutional to the disciplinary pressure provided by debt. Zeckhauser/Pound argue for the latter by suggesting that the presence of a block holder may signal to the market that management is less able to indulge in perquisite consumption. Hence, this reduces the agency costs of equity and alleviates the need for management to use debt as a signal. Therefore, they predict a negative relationship between the presence of external block holders and debt ratios.
Short/Keasey/Duxbury provide another argument in favor of this hypothesis. They argue that the presence of external block holders may force managers to engage in risk shifting as such activities benefit shareholders. Therefore, the agency costs of debt may rise. In combination, higher agency costs of debt and lower agency costs of equity should result in a negative relationship between the presence of external block holders and debt ratios. However, this hypothesis has been supported only by the empirical study of Short/Keasey/Duxbury.
On the contrary, other authors hypothesize a positive relationship between external block holdings and leverage. Friend/Lang argue that external shareholders probably hold more diversified portfolios than managers, therefore being less risk averse and preferring higher debt levels. Furthermore, they suggest that external block holders also might “have higher ability than dispersed shareholders to demand a higher debt to motivate management’s quality totally apart from the tax shield considerations.”
Zeckhauser/Pound suggest that “large shareholders’ monitoring may ensure that management does not shift the firm’s investment policies away from those projects preferred (and expected by) debtholders.” If external block holders lower the agency costs of debt through this way, firms with a large external block holder should have lower costs of debt capital, increasing the debt ratio ceteris paribus. However, large shareholders will exercise their monitoring role only in this way, if they have the right incentives to do so. This may not be the case for the US as national laws prevent some major debtholders, such as banks, from also being large shareholders. The case for Germany, however, is significantly different due to the institutional background. Major debtholders, such as the main private banks, are allowed to and effectively do hold large share blocks in publicly listed companies.
Additionally, there are also arguments for a complementary relationship between debt and monitoring by external block holders as disciplining mechanisms. If external shareholders hold highly diversified portfolios, the costs of monitoring each portfolio firm are likely to be high, making debt more attractive as a governance mechanism. Hence, debt may act as a complement to other disciplinary pressures exerted by external block holders, leading to a positive relationship between the presence of external block holders and debt ratios.
The hypothesis of a positive influence of external block holders on debt ratios has found considerable empirical support with four different studies documenting a significant positive relationship for US and Australian firms. Table 2 provides an overview of those studies including the contradictory findings of Short/Keasey/Duxbury for the UK.
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Table 2 : Overview of Evidence on External Block Holders and Capital Structure
Source: Own Table
In the light of this evidence this thesis hypothesizes a positive relationship between the presence of external block holders and debt ratios, contradicting the hypotheses and evidence of Short/Keasey/Duxbury.
H3: There is a positive relationship between external block ownership and debt ratios.
However, the size of external block holdings for the case of Germany has to be taken into account. In 1996, the median largest ultimate outside voting block for listed industrial companies was 52 percent in Germany, while only 10 percent in the UK and negligible in the US. With increasing exposure of block holders to a single company, their incentives might revert, possibly following the same risk aversion argument proposed for entrenched managers in chapter 2.1.3. Therefore, at some level of ownership external block holders may not want management to take on additional debt. Furthermore, especially when block holders hold a blocking minority or even a majority in a firm, their control mechanisms, such as voting on supervisory board members, interlinking directorships etc., are considerably better. Possibly, this reduces the need for debt as a disciplining device. Consequently, one may conceive that the positive relationship between the presence of external block holders and leverage ceases to exist for block holders owning more than 20 percent of a firm.
H4: The positive relationship between the presence of external block holders and debt ratios becomes insignificant with increasing ownership of the block holder. This is expected to occur after a considerably large stake of 20 percent.
Furthermore, it is argued that there may be an interaction between the influence of management ownership as well as external block owners on debt ratios. This is discussed in the next chapter.
The prior chapter has considered the relationship between external block holders and debt ratios without considering the potential effects on the relationship between management ownership and debt ratios. However, it is plausible to assume that external block holders also have an indirect effect on the leverage decision of the firm via their potential to affect the relationship between leverage and management ownership.
The previous two chapters hypothesized a positive relationship between both management ownership as well as the presence of external block holders and debt ratios. Therefore, it is possible to see both as alternative mechanisms in aligning manager’s incentives with shareholders incentives. As a consequence, one may argue for a substitutional relationship between management ownership and the presence of large block holders. An external block holder actively monitoring and controlling management’s actions, e.g. via directors on the firm’s board, might mitigate the need for managerial ownership as a disciplining mechanism. The large block holder may be expected to have enough power to ensure optimal debt ratios, making the incentive-alignment affect of management ownership unnecessary. This thesis therefore hypothesizes a weakening of the predicted positive relationship between management ownership and debt ratios in the presence of external block holders.
H5: The positive relationship between management ownership and debt ratios becomes insignificant in the presence of external block holders.
The indirect influence of external block holders has so far only been documented by Short/Keasey/Duxbury. They, however, propose and document a negative influence of external block holders on debt ratios. Consequently, their argument concerning the interaction between management ownership and external block holders goes along a different line of thought in proposing a weakening of the positive relationship between management ownership and debt ratios. Nevertheless, their findings do provide evidence that external block holders are able to influence the relationship between management ownership and debt ratios. Given the lack of further empirical evidence, this issue clearly warrants further investigation.
This thesis focuses on the German evidence regarding the link between ownership structure and capital structure. Specifically, German companies listed on the Frankfurt stock exchange and part of the DAX indices are subject of the empirical analysis.
The thesis takes companies from the three indices DAX-30, MDAX and SDAX as its basic sample, resulting in an initial list of 130 firms from classical sectors of the economy. Technology and software firms from the Technology DAX (TecDAX) index are not included due to two reasons. First of all, many of those firms are quite young having been listed in the boom years on the stock exchange, making data availability as well as fluctuations in their capital structure following the initial public offering a concern. Additionally, considering the stock market boom and crash an inclusion of the most heavily affected TecDAX companies might introduce volatility into the measurement of debt ratios. This could mask possible relationships between ownership and capital structure when using market value measures of leverage.
In a next step six banks, four insurance companies and 14 other financial services firms were eliminated from the sample due to their fundamentally different capital structure. After those eliminations the sample size numbered 104 firms. Additionally, three pure holding companies were eliminated, as well as five foreign companies and two companies whose legal type is not Aktiengesellschaft (stock corporation, AG), but Kommanditgesellschaft auf Aktien (limited partnership on shares, KGaA), reducing the sample to 96 firms.
Furthermore, company accounts data from Worldscope was collected for the period 1999 to 2002, eliminating one more company where the requested data was not available. Next, market values for the companies’ outstanding shares were downloaded from Datastream for the period 2000 to 2002 for the remaining 95 firms. Table 3 provides an overview of the sample selection process.
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Table 3 : Sample Selection Process
Source: Own Table
Finally, for the remaining sample of 95 firms data on ownership structures was collected manually as such data is not available from either Worldscope or Datastream.
First of all, shareholder information for the 95 companies remaining in the sample was collected from the Hoppenstedt firm database, which contains detailed ownership information often even listing stakes below the 5 percent legal reporting threshold. This data was cross-checked against the ownership structure reported by Yahoo! Finance, and any inconsistencies found were corrected by reviewing annual reports.
Secondly, shareholder types were identified distinguishing between management as insiders, and external block holders. The management group was subdivided into shareholdings by the management board (Vorstand) and by the supervisory board (Aufsichtsrat). The identification was primarily done by comparing the last names of officers and directors with the shareholder list, adding together all direct stakes to the two categories “officer” (Vorstand) and “board” (Aufsichtsrat). Additionally, related interests such as family stakes as well as trusts likely controlled by the officer or director in question were added to a category “associated”. Furthermore, company websites and news stories where checked for cases, where connections were not directly observable, e.g. when the ultimate controlling party of intermediate holdings was unknown or when family relationships were unclear due to different last names in later generations.
External shareholders were classified into the following categories. All banks, insurance companies, investment trusts etc. were classified into the group “financial”. Blocks held by non-financial corporations were classified as “strategic”, blocks held by the state or local governments were classified as “public”, and all remaining stakes were classified as “other”.
In a next step the data set was cross-checked in order to ensure that the ownership information represented the shareholder structure prevalent at the beginning of 2002. The Hoppenstedt database does not specify the date of the ownership data. Therefore, the voting database of the Bundesanstalt für Finanzdienstleistungsaufsicht (Federal Financial Services Supervisory Office, BAFin), as well as company annual reports and news stories were used to check for any major changes since 2002. If this was the case, company information was used to restore the old ownership structure prevalent at the beginning of 2002.
One additional problem regards the use of dual class shares by 18 firms, which had one voting class (Stammaktien) and one non-voting class (Vorzugsaktien) outstanding. Ownership information by Hoppenstedt was only given for each class, without specifying the exact participation in the share capital. Therefore, this information had to be collected from annual reports and used to rescale the ownership structure to represent cash-flow rights and not voting rights. Table 4 provides descriptive statistics on the ownership structure of the sample with the different shareholder classifications.
illustration not visible in this excerpt
Table 4 : Descriptive Statistics on Ownership Structures
Source: Own Table
 Examples for recent empirical studies on the link between ownership structure and firm performance include Anderson/Reeb (2003); Dessi/Robertson (2003); Zhou (2001); Himmelberg/Hubbard/ Palia (1999); Short/Keasey (1999); Cho (1998); Blasi/Conte/Kruse (1996) and Mehran (1995). Available German studies include Lehmann/Weigand (2000), Edwards/Nibler (2000) and Thonet/Poensgen (1979). The earliest contributions for the United States go back to Elliott (1972); Kamerschen (1968) and Monsen/Chiu/Cooley (1968).
 See chap. 2 for a detailed discussion.
 See Modigliani/Miller (1958); Modigliani/Miller (1963). Another seminal work extending the theory of the irrelevancy of capital structure for firm valuation is due to Miller (1977). Ross/ Westerfield/Jaffe (2002), pp. 390-452, provide a basic overview of capital structure theory.
 See Jensen/Meckling (1976).
 See Myers (2001) or Harris/Raviv (1991) for surveys of non-tax-related capital structure theories.
 See Demsetz (1983), pp. 387-390; Shleifer/Vishny (1986), pp. 461-465, Agrawal/Mandelker (1990), pp. 158-159.
 See e.g. Wald (1999); Baskin (1989); Titman/Wessels (1988); Bradley/Jarrell/Kim (1984).
 If the omitted variable is correlated with the included variables the coefficient estimators are not only biased but also inconsistent. Hence, hypothesis-testing procedures are likely to give misleading conclusions as such correlation is the case for ownership variables. See Gujarati (2003), pp. 510-513.
 See chap. 2 for a detailed account of theoretical and empirical contributions to the literature.
 Studying non-US firms might be advantageous e. g. as it can provide evidence about the effects of large shareholders which are difficult to detect in US data due to the low ownership concentration. See Claessens et al. (2002), p. 2742. Ownership concentration all over the world is higher than in the US, see La Porta/Lopez-de-Silanes/Shleifer (1999), pp. 492-495.
 The debate on the social implications of diffuse ownership had its genesis in Berle/Means (1932). For recent surveys of research on corporate governance and the separation of ownership and control around the world see Denis/McConnell (2003) and Shleifer/Vishny (1997).
 The analysis of agency problems in corporate finance originated with the influential papers of Jensen/Meckling (1976); Myers (1977); Ross (1977); and Leland/Pyle (1977). Barnea/Haugen/ Senbet (1981) provide a generalization of Miller (1977) incorporating the agency costs of debt.
 See Prasad/Green/Murinde (2001) and Short (1994) for surveys of the literature.
 They define an agency relationship „as a contract under which one or more persons (the principal(s)) engage another person (the agent) to perform some service on their behalf which involves delegating some decision making authority to the agent. If both parties […] are utility maximizers, […] the agent will not always act in the best interest of the principal.“ Jensen/Meckling (1976), p. 308. For a first formal discussion of the principal-agent contracting problem see Ross (1973), pp. 134-138.
 The literature on principal-agent problems explores both normative and positive aspects of this potential conflict in decision making. The normative agency theory focuses on the development of optimal contracts between principal and agent. The positive theory of agency is concerned with corporate behavior in the presence of agency conflicts. See Jensen/Smith (1985) for an overview and references.
 See Jensen/Meckling (1976), pp. 312-313. Examples for other internal constraints include debt (Jensen (1986)), dividends (Rozeff (1982), pp. 250-252) and monitoring by the board of directors (Fama/Jensen (1983), pp. 313-315). Suggested external constraints are the managerial labor market (Fama (1980)), product market competition (Hart (1983)), the capital market (Easterbrook (1984), p. 654), and the market for corporate control (Manne (1965); Weisbach (1993)). For a good overview see Hart (1995), pp. 681-686.
 Some authors call it convergence-of-interests hypothesis; see Brailsford/Oliver/Pua (2002), p. 1.
 See Jensen/Meckling (1976), pp. 343-346.
 See Short/Keasey/Duxbury (2002), pp. 377-378.
 See Jensen/Meckling (1976), pp. 343-345.
 See Jensen/Meckling (1976), pp. 346-348.
 Short/Keasey/Duxbury (2002), p. 378.
 Jensen/Meckling (1976), p. 346.
 See Jensen/Meckling (1976), pp. 334-337.
 See Jensen/Meckling (1976), pp. 335-336; Black/Scholes (1972), pp. 649-652.
 The diversification argument is laid out in more detail by proponents of the management entrenchment hypothesis. However, they reach a completely different conclusion. See chap. 2.1.3.
 See Short/Keasey/Duxbury (2002), p. 377.
 See Kim/Sorensen (1986), pp. 141. The idea of sub-optimal investment policy as another agency cost of debt is similar in nature to the asset-substitution problem and was developed by Myers (1977).
 See Anderson/Manzi/Reeb (2003), pp. 274-278. Additionally, a difference-in-mean test suggests that the family firms in their sample have significantly higher leverage, see ibid. p. 274, table 3.
 See Kim/Sorensen (1986); Mehran (1992); Agrawal/Knoeber (1996); Berger/Ofek/Yermack (1997). The latter also includes a change in leverage levels analysis following external shocks to management entrenchment; see Berger/Ofek/Yermack (1997), pp. 1422-1436.
 See Amihud/Lev/Travlos (1990), pp. 610. However, their paper focuses on corporate control considerations as an explanation of observed behavior. See the discussion in chap. 2.1.2.
 See Agrawal/Mandelker (1987), pp. 829.
 See Short/Keasey/Duxbury (2002), pp. 390-392.
 See Leland/Pyle (1977). Other debt signaling models without explicit consideration of management ownership include Ross (1977), Grossman/Hart (1982), Heinkel (1982) and Noe (1988).
 See Harris/Raviv (1988) and Stulz (1988).
 See Leland/Pyle (1977), pp. 371-382. A similar signaling model is developed by Blazenko (1987), who, however, does not incorporate the effects of management ownership.
 See Harris/Raviv (1988), pp. 59-71; Stulz (1988), pp. 28-45. A similar model by Israel (1992), pp. 183-193, determines both capital and ownership structures in equilibrium but does not explicitly establish a relationship between them. See also Israel (1991).
 Stulz (1988), pp. 36-41, also discusses a homemade alternative to the increase in leverage aimed at maintaining control. Analogous to the famous MM argumentation managers could borrow on personal account and use the proceeds to increase their ownership stake, thereby maintaining control. However, this alternative requires a MM world of perfect markets. In reality managers cannot borrow at the same terms as the firm, and may therefore prefer to increase their control by corporate borrowing.
 See Stulz (1988), pp. 43-44.
 See Harris/Raviv (1988), p. 58.
 See Amihud/Lev/Travlos (1990), p. 611.
 Those models are short-run theories of capital structure; see Harris/Raviv (1990), p. 56. See Dann/ De Angelo (1988) for a study of short-run defensive adjustments in ownership and asset structure.
 One argument follows even directly from the incentive-alignment hypothesis presented in chap. 2.1.1. Jensen/Solberg/Zorn (1992) argue that „firms with higher insider ownership should have lower agency costs of equity and higher agency costs of debt because the incentives of managers would be more closely aligned with owners than with creditors.“ ibid., pp. 255-256. Ang/Cole/Lin (2000), pp. 97-104, provide evidence that indeed agency costs decline with increasing management ownership. However, they only examine what is commonly considered as the agency costs of equity (excess expenses) and do not address the agency costs of debt (risk shifting).
 See Jensen (1986), pp. 323-324. However, there remains the question why entrenched managers would voluntarily take on such disciplining debt in the first place; see Zwiebel (1996), pp. 1197.
 See Ross (1977), pp. 25-32; Grossman/Hart (1982), pp. 107-110. Myers (1977), pp. 149-155, however, demonstrates that debt also has undesirable effects weakening managers’ incentives to undertake profitable investments.
 See Short/Keasey/Duxbury (2002), p. 377.
 See Amihud/Lev (1981), p. 606; Smith/Stulz (1985), pp. 399-402.
 See Crutchley/Hansen (1989), p. 37; Easterbrook (1984), p. 653.
 See Ellsworth (1983), pp. 171-175, for anecdotal evidence of managerial risk aversion in general.
 See Hunsaker (1999), pp. 9-13, for a model of debt choice and bankruptcy possibility
 See Friend/Lang (1988), pp. 271-272; Friend/Hasbrouck (1988), pp. 4-6.
 The term management entrenchment in general relates to actions by management which benefit “entrenched” managers and harm shareholders. Other examples of management entrenchment include obvious means such as anti-takeover devices or more subtle means such as manager-specific investments. See Agrawal/Mandelker (1990), pp. 143-147; Shleifer/Vishny (1989), pp. 126-136.
 See Short/Keasey/Duxbury (2002), p. 377; Brailsford/Oliver/Pua (2002), p. 3.
 See Friend/Lang (1988); Friend/Hasbrouck (1988); Jensen/Solberg/Zorn (1992); Bathala/ Moon/Rao (1994); Firth (1995); Moh’d/Perry/Rimbey (1998).
 See Friend/Hasbrouck (1988), pp. 16-17.
 See Friend/Lang (1988), p. 277; Friend/Hasbrouck (1988), p. 12. The authors explain this by apparent multicollinearity in introducing both variables at the same time.
 “A possible explanation of this conflicting evidence is that Friend and Lang use a different data set […]. Their data set is the Official Summary of Securities Transactions and Holdings. Those data may not give them what they attempt to measure, because the SEC requires that the ownership only be given when a trade is made. Thus, a major block holder holding stock but not trading would appear to have zero holdings.” Mehran (1992), pp. 552. See Kole (1995), pp. 415-419, for an overview of three more widely used sources for US ownership data, the Value Line Investment Survey, Corporate Data Exchange Volumes and company proxy statements.
 See Firth (1995), p. 169-172.
 See Jensen/Solberg/Zorn (1992), pp. 248-249; who study the interdependence of the debt, ownership and dividend decision using three stage least squares (3SLS). Bathala/Moon/Rao (1994), pp.41-43, examine a simultaneous equations framework with debt and ownership as endogenous variables using two stage least squares (2SLS).
 See Bathala/Moon/Rao (1994), pp. 46-47.
 Endogeneity means that managerial ownership may not be an exogenous variable in the determination of capital structure, but rather be endogenously set in a simultaneous decision.
 See Moh’d/Perry/Rimbey (1998), pp. 91-93.
 Additionally, Agrawal/Nagarajan (1990), pp. 1325, also support the entrenchment hypothesis by finding significantly higher managerial ownership in all-equity firms, suggesting that managerial control of voting rights is one important factor in the decision to eliminate leverage.
 Actually, this suggestion is due to Short (1994), p. 243.
 Studies by Short/Keasey (1999); McConnell/Servaes (1995); Hermalin/Weisbach (1991); McConnell/Servaes (1990); Wruck (1989); and Morck/Shleifer/Vishny (1988) find a non-linear relationship between management ownership and performance. They suggest that at low levels of management ownership performance is increased due to the incentive-alignment effect. However, at higher levels of management ownership the entrenchment effect sets in, increasing agency conflicts and reducing firm performance.
 See Brailsford/Oliver/Pua (2002), pp. 3-4. Grier/Zychowicz (1994), pp. 5-8, also report a non-linear inverted U-shape relationship between insider ownership and leverage for US data.
 However, the study only employs a relatively small sample of 49 firms, running an OLS regression on a pooled sample over four years with 189 observations. Nevertheless, the authors’ robustness checks partly mitigate the concerns over the sample size. See Brailsford/Oliver/Pua (2002), pp. 20-23.
 Haugen/Senbet (1979), pp. 686-692, even construct a model where informational asymmetry and agency problems can be jointly and costless resolved through contingent contracts. The solution plays no role in the determination of the financial structure of the firm, suggesting no relationship at all between ownership structure and capital structure. However, Darrough/Stoughton (1986), pp. 501-503, provide a more advanced model of moral hazard and adverse selection reconciling the observed diversity of ownership and capital structures as a natural response to market imperfections.
 See the detailed discussion in chapter 2.1.1.
 Obviously, those two hypotheses are in a way conflicting as H1 predicts a linear relationship between management ownership and debt ratios, while H2 favors a non-linear relationship. However, H2 is seen as an exploratory additional hypothesis as the word “may” shall indicate, while H1 is one of the main hypotheses examined in this thesis.
 A “block“ is commonly defined as a stake above a certain threshold such as 5 or 10 percent.
 “Institutional investors” are commonly defined as an aggregate group including insurance companies, pension funds, investment trusts etc. See Short/Keasey/Duxbury (2002), p. 379.
 See Chaganti/Damanpour (1991); Grier/Zychowicz (1994); Bathala/Moon/Rao (1994); Firth (1995); and Moh’d/Perry/Rimbey (1998) for the influence of institutional shareholders on capital structure. See Friend/Lang (1988); Zeckhauser/Pound (1990); Mehran (1992); Berger/Ofek/ Yermack (1997); Short/Keasey/Duxbury (2002); and Brailsford/Oliver/Pua (2002) for the influence of external block holders on capital structure.
 See Becht/Boehmer (2003), pp. 7-15; Becht/Boehmer (1997), pp. 77-81. Becht/Boehmer (2003), p. 7-9, report that only 1.6 percent of all 430 firms listed on an official German market in 1996 had no block holder owning more than 5 percent of voting rights.
 See Brickley/Lease/Smith (1988), pp. 271-284.
 See Stiglitz (1985), pp. 136. Essentially, this is a problem of collective choice.
 See Stiglitz (1985), pp. 144.
 See Shleifer/Vishny (1986), pp. 465-471. Burkart/Gromb/Panunzi (1997), pp. 693-696, however, challenge the notion that this is purely beneficial.
 See Pound (1988), pp. 242-244.
 See Bolton/von Thadden (1998a) and Bolton/von Thadden (1998a) for a discussion on the apparent trade-off between liquidity and control.
 See Maug (1998), p. 66.
 See Agrawal/Mandelker (1990), pp. 147-158, for support for the active-monitoring hypothesis.
 Therefore, the examination of the influence of external block holders is a two-staged question. Firstly, the question whether there is an influence at all, i.e. active monitoring vs. passive voting hypothesis And secondly, whether this influence is positively or negatively related to debt ratios.
 See Zeckhauser/Pound (1990), pp. 171-176; Grier/Zychowicz (1994), pp. 2-3.
 See Short/Keasey/Duxbury (2002), p. 380.
 See Short/Keasey/Duxbury (2002), p. 392. Zeckhauser/Pound (1990), pp. 175-176, also find a negative but insignificant influence of external block holders on debt ratios. Additionally, Chaganti/ Damanpour (1991); Grier/Zychowicz (1994); Bathala/Moon/Rao (1994) and Moh’d/Perry/ Rimbey (1998) report significant negative effects of institutional shareholdings on debt ratios.
 See Friend/Lang (1988), pp. 272-273, quote on p. 273.
 Zeckhauser/Pound (1990), p. 173.
 See Zeckhauser/Pound (1990), pp. 173-174.
 In 1996, Deutsche Bank held 27 blocks bigger than 5 percent in the 430 officially listed German firms. Dresdner Bank held 14 and Commerzbank 8 such blocks. See Becht/Boehmer (2001), pp. 11. Kester (1986), p. 7, suggests a similar argument as an explanation for significantly higher leverage in Japanese manufacturing firms than in their US counterparts, ibid. p. 13. However, Mayer (1996), pp. 13-14, reports that share ownership by financial institutions in general is lower in Germany than in the US. Most significant share blocks are held by families or non-financial companies.
 See Short/Keasey/Duxbury (2002), p. 389-380.
 See Friend/Lang (1988); Mehran (1992); Berger/Ofek/Yermack (1997) for the US and Brailsford/Oliver/Pua (2002) for Australian evidence.
 Exhibit 1 in the appendix combines figures 1 and 2 in a complete overview of prior research on the link between ownership structure and capital structure. See Short (1994), pp. 236-238, and Prasad/ Green/Murinde (2001), pp. 76-78, for more detailed overview tables.
 See Becht/Röell (2003), p. 1052. More precisely, the median for the US was below the 5 percent reporting threshold.
 Franks/Mayer (2001), p. 944, report that 85 percent of the largest quoted companies have a block holder owning more than 25 percent of voting shares.
 This cut-off is quite arbitrary, especially as such a hypothesis has not been examined empirically so far. Therefore, other values such as 10, 15 and 25 percent are used in robustness tests in chap. 3.3.2.
 Again, H4 is in a way conflicting with H3 as the latter predicts a linear positive relationship between external block holders and debt ratios, while the later hypothesizes a non-linear relationship. However, as so far only linear relationships have been found empirically, H3 is considered the second main hypothesis of this thesis, while H4 is an additional exploratory hypothesis.
 See Short/Keasey/Duxbury (2002), p. 381.
 See Short/Keasey/Duxbury (2002), p. 381. In addition to their findings Firth (1995), pp. 171-174, reports evidence on an interaction effect between institutional shareholdings and management ownership. He, however, documents a negative influence of management ownership on debt ratios, which is mitigated by the presence of institutional shareholders.
 The DAX indices are partitioned into the DAX-30 including Germany’s 30 largest listed companies, the MDAX containing 50 mid-cap stocks from classical sectors directly following the DAX-30, and the SDAX containing 50 small-cap stocks directly following the MDAX in a ranking of market capitalization and turnover. See Deutsche Börse Group (2003), pp. 5-6.
 The current index constituent list from September 22nd, 2003, was used, although the empirical analysis examines the period 2000 to 2002. However, data availability with regard to ownership structure is considerably better for firms’ part of the index at the time of data collection, warranting this approach. See also chapter 3.2.2 for the discussion of ownership structure variables.
 With the two exceptions of Infineon AG and SAP AG, which are technology firms in the DAX-30.
 See chap. 3.2.3 for a discussion of the measurement of capital structure using book and market values of equity. Anderson/Manzi/Reeb (2003), p. 1326, note an improvement in their results when excluding technology companies from their regression.
 The pure holdings are WCM AG, Deutsche Beteiligungsgesellschaft AG and Hornbach Holding AG.
 Foreign companies excluded from the sample were EADS NV (Netherlands) and Thiel Logistik AG (Luxemburg) from the MDAX, as well as Gericom AG (Austria), Highlight Communications AG (Switzerland) and Teleplan International NV (Netherlands) from the SDAX.
 The companies were Henkel KGaA and Merck KGaA.
 Worldscope and Datastream are commercial databases available from Thomson Financial Network. An advantage of Worldscope balance sheet data is the comparability across different reporting regimes (e.g. HGB and IAS/IFRS) due to adjustments made to the data. See Wald (1999), pp. 162-163.
 The company was Norddeutsche Affinerie AG.
 Such data has only recently become available. Under the German Securities Trading Act (Wertpapierhandelsgesetz, WpHG), the 1995 German transposition of the European Commission’s Transparency Directive, shareholders owning directly or indirectly more than 5 percent of a listed company’s voting stock are required to report their holdings Under the pre-1995 disclosure regime mandatory disclosure regarded only direct cash-flow stakes of 25 percent or more. See Becht/Boehmer (2003), pp. 4-6.
 The Hoppenstedt firm database is available for subscribers at http://www.firmendatenbank.de. Yahoo! Finance is available for free at http://de.finance.yahoo.com. According to Börsch-Supan/Köke (2002), p. 303, there are two more comprehensive and suitable commercial sources providing data sets (especially panel data) on ownership structure: the Amadeus database and the Hoppenstedt Konzernstrukturdatenbank. However, data from those sources could not be obtained for this thesis.
 For example, for Bayerische Motoren Werke AG, Stefan Quandt and Susanne Klatten are members of the supervisory board, therefore their stakes are counted into the category “board”. On the other hand, Günther Fielmann is Chief Executive Officer (CEO, Vorstandsvorsitzender) of Fielmann AG, so that his block is classified as “officer”.
 E.g. the stake of Johanna Quandt was counted as associated to Stefan Quandt, and the stakes of Marc Fielmann, fielmann inter-Optik and the Fielmann family trust as associated to Günther Fielmann.
 Including stakes held by the state-owned development bank Kreditanstalt für Wiederaufbau (KfW).
 The group „other“ encompasses diverse shareholders such as mixed holding companies (e.g. Francommerz, which is owned by RWE, Allianz and Commerzbank), passive family trusts (e.g. Krupp Stiftung), individuals (e.g. Guy Wyser Pratte), private equity investors (Carlyle, WCM), as well as foreign governments (Iran, Kuwait and Abu Dhabi).
 The BAFin voting database is publicly available at http://www.bafin.de/database/stimmrechte.htm.
 There were only two major changes. For Wella AG and ProSieben Sat1 Media AG the ownership structures had to be restored after the takeovers by Procter&Gamble and the Haim Saban consortium, respectively. This indicates that the Hoppenstedt database is regularly updated in this regard only for big ownership changes, as smaller transactions such as the Puma block trade by Monarchy Enterprises in 2003 were not considered yet, as well as very recent changes such as the Beiersdorf deal between Tchibo and Allianz.
 The voting shares of three firms were not publicly listed. The founding families hold 100 percent of voting shares for Villeroy & Boch AG and Jungheinrich AG. Kirch Media GmbH & Co KGaA and Axel Springer Verlag AG held 100 percent of the voting shares of ProSieben Sat1 Media AG in 2002.
 The participation of non-voting shares in the share capital ranged from 1 percent (Metro AG) to the legal maximum of 50 percent (5 firms). Chap. 3.3 provides robustness tests to check for any significant differences between firms using non-voting shares and firms following the one-share-one-vote principle. One apparent fact is that in almost all firms using dual classes of common stock management tended to hold only voting shares (Stammaktien), implying increased voting rights accompanied by lower cash flow rights. See De Angelo/De Angelo (1985) for a discussion of US firms and Boehmer (1999), pp. 3-4, for a discussion of ownership versus voting rights in Germany.
 See exhibits 2-4 in the appendix for descriptive statistics on DAX, MDAX, and SDAX sub-samples.
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