Private Benefits of Control: An International Comparison

We construct a measure of the private benefits of control in 39 countries based on 393 control transactions between 1990 and 2000. We find that the value of control ranges between –4% and +65%, with an average of 14 percent. As predicted by theory, in countries where private benefits of control are larger capital markets are less developed, ownership is more concentrated, and privatizations are less likely to take place as public offerings. We also analyze what institutions are most important in curbing these private benefits. A high degree of statutory protection of minority shareholders and high degree of law enforcement are associated with lower levels of private benefits of control, but so are a high level of diffusion of the press, a high rate of tax compliance, and a high degree of product market competition. A crude R-squared test suggests that the “non traditional” mechanisms have at least as much explanatory power as the legal ones commonly mentioned in the literature. In fact, in a multivariate analysis newspapers’ circulation and tax compliance seem to be the dominating factors. We advance an explanation why this might be the case. * Chris Allen, Omar Choudhry and Mehmet Beceren provided invaluable research assistance in preparing the data. We thank John Matsusaka, Tatiana Nenova, Krishna Palepu, Mark Roe, Julio Rotemberg, Abbie Smith, Rene Stulz, Debora Spar, Per Stromberg, an anonymous referee, and seminar participants from Georgetown University, Harvard Business School, the NBER corporate finance program, The University of Chicago, the University of Pennsylvania (Wharton), and the University of Southern California for helpful comments. We also gratefully acknowledge financial support from Division of Research, Harvard Business School, the Center for Research on Security Prices and the George Stigler Center at the University of Chicago. Traditional finance assumes that all common stock has been created equal and each shareholder receives the same payoff per share owned. In the last twenty years, however, a different view has slowly gained acceptance. According to this new view, a controlling shareholder can obtain some benefits that are not shared by other shareholders (the so-called private benefits of control). From a modeling device (Grossman and Hart (1980)) the idea of private benefits of control has become a centerpiece of the recent literature in corporate finance, both theoretical and empirical. In fact, the focus of the literature on investor protection and its role in the development of financial markets (La Porta et al. (2000)) is not on managerial agency problems, but on the amount of private benefits that controlling shareholders extract from companies they run. In spite of the importance of this concept, there are remarkably few estimates of how big these private benefits are, even fewer attempts to document empirically what determines their size, and no direct evidence of their impact on financial development. All of the evidence on this later point is indirect, based on the (reasonable) assumption that better protection of minority shareholders is correlated with higher financial development via its curbing of private benefits of control (La Porta et al. (1997)). The lack of evidence is no accident. By their very nature private benefits of control are difficult to observe and even more difficult to quantify in a reliable way. A controlling party can appropriate value for himself only when this value is not verifiable (i.e., provable in court). If it were, it would be relatively easy for non-controlling shareholders to stop him from appropriating it. Thus, private benefits of control are intrinsically difficult to measure. To be true, there are two methods to try to quantify them. The first one, pioneered by Barclay and Holderness (1989), focuses on privately negotiated transfers of controlling blocks in publicly traded companies. The price per share an acquirer pays for the controlling block reflects the cash flow benefits from his fractional ownership and the private benefits stemming from his controlling position in the firm. By contrast, the market price of a share after the change in control is announced reflects only the cash flow benefits non-controlling shareholders expect to receive under the new management. Hence, as Barclay and Holderness (1989) have argued, the difference between the price per share paid by the acquiring party and the price per share prevailing on the market reflects the differential payoff accruing to the controlling shareholder. In fact, after an