A high ownership concentration does not necessarily produce an over-investment. In fact, if prevails the risk aversion of major shareholders who own undiversified portfolios, there may be the phenomenon of underinvestment. What do you think?
Thanks in advance for your helpful suggestions and comments.
Hi Fabrizio!
I try some cautious comments. To my mind, it depends if the firm is financially constrained or not. As R&D investment may be inflexible, a financially constrained R&D-intensive firm is more likely not to adopt the optimal level of required investment in that field (under-investment).
Now if the ownership is concentrated, The investment decision may depend of the nature of the blockholder (financially constrained or not). A family blockholder may be reluctant to invest a lot since its portfolio may be non diversified. But an institutional investor well diversified (pension funds, and so on) may be inclined to go further and perhaps to over-invest.
Now, if we consider a very diffuse ownership, and no too strong financial constraints, i don't see why the optimal level of risky investment wouldn't be chosen by the CEO of the company, except if he becomes entrenched.
Well that's just a first glance!
best regards.
One could argue that the undiversified major stockholders are not as risk averse; if they were, they would not be so undiversified.
Given this, there is no reason for them to either underinvest or, for that matter, to overinvest.
Dear Gerald Lobo,
As you know, when the ownership concentration is very high (and the family business model is widespread, as in Italy), the controlling shareholders invest all, or almost all, of the resources in the company and, therefore, to diversify their portfolios is more difficult. Therefore, in this context, it is likely the phenomenon of the sub-optimal investments can be a serious question.
Dear Patrick,
I quite agree with you. I add, however, that in addition to the problem "if the firm is financially constrained or not", there is an issue of risk-taking, in particular when the ownership is highly concentrated.
In my opinion, underinvestment and overinvestment are two sides of the same coin.
Hello Fabri,
I agree with you. over investment and underinvestment present inherent risks. Ownership concentration is a big issue in finance. What lessons have we learned since 2008? Are we going to follow the same path with all those shadow financial instruments? Then we wait for another crisis to occur to analyze and discuss postmortem effects of the causes of the crisis.
Investment in R&D pretty well depends on the type of industry. High-tech and fashion businesses are compelled to invested in R&D regardless of ownership concentration probably as means to survive and grow in turbulent and very often unpredictable markets.
Dear Fabrizio,
It appears to me that Gerald assumes a lack of risk aversion of part of non-diversified owners just because they are not diversified. But your point is that in the family business model non-diversification is not a deliberate Investment decision, but a consequence of budgetary constraints - there is simply not enough cash to invest elsewhere. These constraints may also be intensified by the emotional bond to the family enterprise.
However, especially in R&D cases, investment necessity and thus the risks connected with such Investments might by dictated by business needs. This might happen if the current technology of the company becomes outdated or in case of a market driven by innovation. I am not sure whether corporate governance arrangements can provide a solution to the problem if we do not take the Business environment into consideration.
Paul
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