Performance of private companies : an empirical investigation into the role of control, risk and incentives
This thesis analyses empirically the determinants of company performance. Its scope is restricted to private companies and to the issues of control, risk and incentives. Chapter two studies the effects of the private benefits of control on private British companies with limited liability. We hypothesise that companies in which existing owners would lose more control if they expanded, have smaller equity increases, are more highly levered and grow more slowly. Potential loss of control is measured as the difference in the probability of winning a vote for the largest owner before and after a hypothetical equity increase. The empirical results are broadly consistent with the hypotheses. Chapter three studies the influence of owners' underdiversification on the profitability of private US companies. Theory suggests that underdiversification increases the returns required for investment. We find a strong positive relationship between underdiversification (measured as the share of personal net worth invested), and profitability (measured as the return on equity). The analysis identifies two causes for this effect: higher required returns and higher effort. Chapter four studies the influence of owners' underdiversification on the financial structure of their companies. Higher underdiversification is related to a higher demand for loans, higher leverage and lower liquidity. Bank loans are therefore used as an alternative source of financing that reduces the exposure of the owner to company- specific risk caused by the equity investment. Chapter five studies the effects of the share of managerial ownership on performance and the determinants of this share for German private companies with limited liability. Ownership up to around 80 percent has a positive impact on performance (incentive effect), for higher ownership the effect becomes negative (entrenchment effect). The risk-aversion of owner-managers and signalling of company quality lead to a non-linear relationship between the company's riskiness and ownership.