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Management and CEO Stock Ownership

And its Effect on Company Performance

Written by Daniel Kamanga, Richard Sundin

Paper category

Bachelor Thesis


Business Administration>Management




Thesis: The Efficient Market Hypothesis Fama [11] defines an efficient financial market as "a market where prices always ‘fully reflect’ available information". Fama points out that there are three subsets of the efficient market hypothesis; weak, semi-strong, and strong. The weak form hypothesis assumes that the market only reflects past information, and returns are distributed equally and independently. Semi-strong form assumptions include information available to the public, such as announcements about annual net income and stock splits. The strong formal assumption includes private information. If it is true, insiders cannot profit from private information. According to Fama, the strong form is unlikely to hold. Fama further believes that the hypothesis of weak and semi-strong forms of efficient markets is highly supported by empirical evidence. Especially securities analysis [6]. However, Schleifer [6] pointed out that since the 1980s, both the theoretical and empirical support for the efficient market hypothesis have been challenged. The mechanism considered to be the key factor in achieving efficiency is more limited than originally thought [6]. In addition, there are some findings that can be interpreted as market anomalies (or inefficiencies), and once they appear, they will disappear. Observe [29]. Schwert [29] pointed out that early anomalies, such as scale effect and value effect, have lost their influence on stock price changes. Schwert further pointed out that if professional traders try to use the anomalies found to provide high returns, their efforts can eliminate the anomaly. Therefore, research can make the market more efficient [29]. 2.2 The principal-agent problem How many shares a CEO should hold and how they should be paid are a classic application of the principal-agent problem. One of the earliest people to discuss the issue of principal-agent is Ross[25], who described this phenomenon as "When a party designated as an agent acts as a representative or as a representative of the other party, the principal People". In this article, the CEO and management can be regarded as agents, and shareholders can be regarded as principals. Since executives usually only own a small part of the company's total equity, executive incentives are inconsistent with shareholder goals, so problems may arise [31]. 2.3 Previous research on management and CEO ownership The three examples written by Lewellen et al. show that there is a positive and significant relationship between executive ownership and company performance. [28], Von Lillienfield-Toaland Ruenzi [27] Habib and Ljungqvist [20]. However, Himmelberg et al. did not show its importance. [8] As well as Demsetz and Villalonga [13]. Most studies define company performance as the company’s performance in terms of shareholder returns. However, ownership is also related to other forms of performance, such as changes in company value (via Tobin's q) and internal measures such as return on assets. Von Lillienfield-Toal and Ruenzi [27] found that the impact of CEO ownership is the strongest for companies. -Enterprises with weak external governance, weak product market competition, and large management discretion. For companies with these characteristics, Von Lillienfield-Toal and Ruenzi believe that CEO ownership can reverse the negative impact of weak external governance. Von Lillienfield-Toal and Ruenzi also found that a CEO with a high degree of ownership can more effectively reduce empire building and operating companies. Von Lillienfield-Toal and Ruenzi classify companies into portfolios based on the level of management ownership. The influence of ownership is controlled by adding components to the three-factor model of Fama and French [12], including the beta factor, scale factor, and momentum factor, as well as the company characteristics in the regression. For the selection of company characteristics, one of which is the dividend yield, Von Lillienfield-Toal and Ruenzi follow the method of Brennan et al. [21]. Von Lillienfield-Toal and Ruenzi [27] pointed out that if the market is not fully efficient, then based on the argument of asymmetric information, CEO ownership may lead to abnormal returns (they assume that the higher the CEO’s ownership, the higher the company’s market value) ) For example, when the CEO realizes that the company is undervalued or wants to demonstrate good project quality to external investors by investing in the company. The former was demonstrated by Lin and Howe [16], and the latter was demonstrated by Leland and Pyle [15]. Von Lillienfield-Toal and Ruenzi continue to point out that when the CEO ownership purchase is officially effective in the effective market, the company's market value will immediately jump. In addition, this should not have any impact on the long-term returns after the information asymmetry is resolved. However, in an inefficient market, the impact of CEO ownership purchases will not be so immediate, and there may be abnormal returns in the future. Lewellen et al. [28] A study was conducted on 49 companies in the Fortune 500 list from 1964 to 1969, and annual regressions were performed, corresponding to 294 observations. The study found that there is a positive correlation between company performance and ownership on a relative level, but there is no positive correlation on an absolute level. Read Less