OWNERSHIP AND PERFORMANCE IN CLOSE CORPORATIONS: A NATURAL EXPERIMENT IN EXOGENOUS OWNERSHIP STRUCTURE

Abstract

Close corporations account for 51 percent of the private sector output and 52 percent of all private employment in the US. Understanding governance issues facing these firms is therefore of considerable importance. Legal scholars extensively recommend that the main shareholder in close firms surrender some control to minority shareholders at the outset in order to improve overall firm performance. With shared control rights, no shareholder can take unilateral actions for her own benefit at the expense of the firm and other shareholders. In two independent samples of close corporations, we find this to be the case, with shared ownership firms reporting substantially larger return on assets (by 4 to 12 percentage points) and lower expense-to-sales ratios. An important reason why this result establishes the role of ownership in firm performance is the absence of a ready market for shares in close corporations. This illiquidity makes the ownership structure a historical, statistically predetermined measure, allowing us to sidestep the ownership endogeneity problem confronting ownership-performance studies of public firms