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Explore the relationship between personal stock loans taken by controlling shareholders and firm performance. Includes analysis of ownership structures, financing alternatives, and implications for asset substitution. Evidence suggests both positive and negative effects of stock loans on risk and performance.
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The controlling shareholder’s personal stock loan and firm performance Yehning Chen and Shing-yang Hu* National Taiwan University
1. Introduction Ownership and control Separation Concentration Stock Loan and Performance
1. Introduction Controlling shareholder firms La Porta, Lopez-de-Silanes, and Shleifer (1999) Claessens, Djankov, and Lang (2000) Faccio and Lang (2000) Stock Loan and Performance
1. Introduction Controlling shareholder firms How to maintain control given personal wealth constraint and diversification? Stock Loan and Performance
1. Introduction Ownership structure Pyramid Cross-shareholding Multiple classes of shares Stock Loan and Performance
1. Introduction Ownership structure Disadvantage Full disclosure Slow adjustment Stock Loan and Performance
1. Introduction Personal loan secured by stock Advantage Take good investment projects Retain ownership control Disclosure Easy adjustment Stock Loan and Performance
1. Introduction Stock loan - Personal loan secured by stock Disadvantage Risk of falling stock price and losing control Agency problem – asset substitution Stock Loan and Performance
1. Introduction Contribution Suggest a positive effect of stock loan and provide supporting evidence Suggest a negative effect of stock loan on risk and provide supporting evidence Stock Loan and Performance
1. Introduction U.S. WorldCom's CEO Bernard J. Ebbers New York Times (August 10, 2001) Personal finance Owned U.S.$238 million worth of WorldCom and MCI stock Owed more than $268 million on loans secured by stock Firm decision WorldCom paid $2.4 cash dividend to MCI stock (21.4% yield) WorldCom guaranteed $100 million personal loan WorldCom provided $75 million personal financing Stock Loan and Performance
2. Model Risk neutral and rational investors Risk free rate is zero Three-date (dates 0, 1, and 2) Date 0: Decide whether to obtain an investment opportunity at a cost $1 Date 1: Choose between a safe project and a risky project. Date 2: Payoff realized Stock Loan and Performance
2. Model Date 0 Date 1 Date 2 Obtain Investment Opportunity? Choose safe or risky project? 1 p R Yes 1-p r No p unknown p known Stock Loan and Performance
2. Model Financing alternatives at date 0 Invest his own money: maximum is W Issue corporate equity: E ((1-)%) Issue corporate bond: B (face value D) Borrow personal loan secured by his equity: X (F) All security is fairly priced Stock Loan and Performance
2. Model Assumptions 1. The entrepreneur has to own at least 0 2. Corporate bond has to be riskless: D r 3. Stock loan financing is risky Stock Loan and Performance
2. Model Result 1. Given F>0 and invests at date 0, the entrepreneur is more likely to choose the risky project when F increases. Implication Stock loan financing creates incentive for asset substitution Stock Loan and Performance
2. Model Result 2. Given F>0 and the entrepreneur invests at date 0, the amount of money the entrepreneur can raise is increasing in F. Implication Stock loan financing allows the entrepreneur to raise more money and invest at date 0. Stock Loan and Performance
3. Sample Firm characteristics variables LOAN: % shares secured for personal loan D/A: % debt-to-asset ratio in book values SHARE: % shares owned by the board Q: Market-to-book value of assets Measured at the end of 1996:11, 1998:10, 2000:8 Stock Loan and Performance
3. Sample Firm performance variables Accounting return ROA or ROE: annualized average quarterly return σ(ROA) or σ(ROE): standard deviation of seasonal-adjusted quarterly return 1994:IV-1996:III, 1996:IV-1998:III, 1998:IV-2000:III Stock Loan and Performance
3. Sample Firm performance variables Stock return RET: annualized average stock return σ(RET): annualized standard deviation of monthly stock return 1995:1-1996:11, 1996:12-1998:10, 1998:11-2000:8 Exclude extreme observations Stock Loan and Performance
3. Sample Stock Loan and Performance
3. Sample Stock Loan and Performance
3. Sample Stock Loan and Performance
4. Results – Determinants of stock loan ΔLOANit =α+β1ΔQit +β2CASHit + β3Δσ(RET it)+β4ΔASSETit +εit. Stock Loan and Performance
4. Results – Determinants of stock loan Stock Loan and Performance
4. Results – Stock loan and risk σ(R it) =α+β1σ(R i, t-1)+β2LOANi, t-1 +β3 D/A i, t-1 +β4 SHAREi, t-1+εit Stock Loan and Performance
4. Results – Stock loan and risk Stock Loan and Performance
4. Results – Stock loan and performance R it = α+β1R i, t-1+β2LOANi, t-1 + β3 D/A i, t-1 +β4 SHAREi, t-1+εit Stock Loan and Performance
4. Results – Stock loan and performance Stock Loan and Performance
4. Results – Stock loan and performance R it = α+β1R i, t-1+β2LOANi, t-1 +β3 D/A i, t-1 +β4 SHAREi, t-1 + β5 σ(R it) +εit Stock Loan and Performance
4. Results – Stock loan and performance Stock Loan and Performance
5. Conclusion Stock loan provide financing to good projects Stock loan creates agency cost – increasing risk Stock loan creates agency cost – hurting performance Agency cost from stock loan is time-varying Stock Loan and Performance
