Ownership structure and diversification in a scenario of weak shareholder protection

Abstract

This work examines the influences of ownership concentration and insider ownership on corporate strategies for diversification within a scenario characterized by poor protection of shareholder interests. We find evidence of a quadratic relationship between ownership concentration and diversification, and a cubic relationship between diversification and insider ownership. These results point towards the high probability of both expropriation and entrenchment phenomena, respectively, in this kind of scenario. We also find that concentrated ownership requires high levels of insider ownership, in order to prevent negative externalities of diversification. Another result shows that entrenchment externalities affect diversification before they erode firm value, which suggests that for low levels of diversification, firm value is still not negatively affected. Additionally, our results show that control mechanisms, such as debt, director remuneration and compliance with codes of good practice, are negatively related to the level of diversification. Overall, our results confirm the theoretical relevance of agency theory in explaining managerial attitudes towards corporate strategy, i.e. diversification. Furthermore, companies characterized by deficiencies in shareholder legal protection, concentrated ownership structures and a higher likelihood of managers being entrenched, should focus on the correct functioning of corporate governance mechanisms.