Ownership Structure as a Determinant of Capital Structure - An Empirical Study of DAX Companeis

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- 1 - 1 Introduction

1.1 Problem and Objective of the Thesis

The idea that the general characteristics of a firm’s ownership structure can affect per-formance 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. ¹ 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. 2

Since the capital structure irrelevance propositions of MODIGLIANI/MILLER (MM) ³ 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 ⁴ has employed an agency theory perspective in the search for an explanation of capital structure variations. ⁵ 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. 6

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. ⁷ 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 misspecifica-

¹ 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 THO- NET/POENSGEN (1979).The earliest contributions for the United States go back to ELLIOTT (1972); KAMERSCHEN (1968) and MONSEN/CHIU/COOLEY (1968).

² See chap. 2 for a detailed discussion.

³ 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.

⁴ See JENSEN/MECKLING (1976).

⁵ See MYERS (2001) or HARRIS/RAVIV (1991) for surveys of non-tax-related capital structure theories.

⁶ See DEMSETZ (1983), pp. 387-390; SHLEIFER/VISHNY (1986), pp. 461-465, AGRAWAL/MANDELKER (1990), pp. 158-159.

⁷ See e.g. WALD (1999); BASKIN (1989); TITMAN/WESSELS (1988); BRADLEY/JARRELL/KIM (1984).

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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). 10

1.2 Organization of the Thesis

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 (H 1 and H 2 ). Secondly, chapter 2.2 introduces theory and evi-

⁸ 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.

⁹ See chap. 2 for a detailed account of theoretical and empirical contributions to the literature.

¹⁰ 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.

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- 4 - 2 The Relationship Between Capital Structure, Management

Ownership and External Block Holders - Prior Research and

Hypotheses

BERLE/MEANS argued over 70 years ago that the modern corporation is characterized by a separation of ownership and control. ¹¹ Since then a large body of theoretical and empirical literature has developed analyzing the effects of ownership and control on the firms operations. ¹² A considerable part of this literature concerns theories and evidence on the relationship between ownership structure and capital structure ¹³ , 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.