The Effect of Ownership Structure on Underinvestment and Overinvestment Processes

This paper investigates how insider ownership and ownership concentration influence a firm's investment-cash flow sensitivity. We propose a new empirical approach that allows us to account for the non-linearities of ownership structure with respect to firm value, and to distinguish between firms according to their propensity to suffer from underinvestment or overinvestment processes. The empirical evidence is obtained by estimating an extended version of the q model of investment that incorporates capital market frictions. This model has been estimated by the generalized method of moments (GMM), which allows us to control for the endogeneity problem by using instruments, and for unobservable heterogeneity through an individual effect. First, our results show that there are no differences in the role played by ownership structure between underinvestor and overinvestor firms, since the alignment of interests between owners and mangers and the monitoring by concentrated ownership both alleviate the investment-cash flow sensitivity of firms in general. Second, we find that managerial entrenchment and expropriation phenomena do cause a shift in this effect, since they exacerbate the conflicts of interests between main stakeholders and, consequently, underinvestment and overinvestment processes worsen