Ownership Structure and Diversification in a Scenario of Weak Shareholder Protection

We examine the influence of ownership concentration and insider ownership on the selection of corporate strategies of diversification in a scenario characterized by poor protection of shareholders' interests. We find evidence of a quadratic relationship between ownership concentration and diversification and a cubic relationship between diversification and insider ownership, which evidence the likeliness of both expropriation and entrenchment phenomena, respectively, in this kind of scenario. It also suggests that sometimes the costs of the principal-principal conflict are more severe than the managers-shareholders conflict. We also uncover that concentrated ownership requires high levels of insider ownership in order to prevent the negative externalities of diversification, a result which could be expected a priori for low shareholder protection countries. Other innovative result shows that entrenchment externalities affect diversification before it erodes firm value, which is also a proof that for low levels of diversification, firm values is still not negatively affected. Additionally, our results show that control mechanisms such as debt, directors' remuneration and the compliance with codes of good practices are negatively related to the level of diversification. All in all, our results confirm the theoretical relevance of the agency theory in explaining the managerial attitudes towards corporate strategy, i.e., diversification. Furthermore, companies located in civil-law countries, characterized by deficiencies in legal shareholder protection, concentrated ownership structures and a higher likeliness of managers being entrenched, should place their emphasis on enhancing the correct functioning of corporate governance mechanisms. In fact, our results corroborate the relevance of these mechanisms to promote firm value maximizing strategies