Tag: incentives

Ownership Structure, Acquisitions and Managerial Incentives

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Both the theoretical and empirical literature assume that takeovers are less likely to occur when firms have large concentrated shareholders, e.g. family firms. Hence the disciplinary role of takeovers becomes irrelevant in incentivizing the management. We argue that this conjecture is false. Using a contracting model, we show that the existence of takeovers can work in favour of firms with controlling shareholders, amplifying the disciplinary effects relative to firms with dispersed shareholders. We further show how takeover threats interact with alternative governance structures, specifically, with monitoring and performance pay. While carrots (performance pay) and sticks (takeover threat) play substitute roles in incentive provision, the internal monitoring available to large shareholders is a substitute mechanism irrespective of the disciplinary effect of the market for corporate control.


The nature of optimal corporate ownership has been a longstanding question in corporate governance literature.  While large controlling shareholders can address managerial agency problems by monitoring management and alleviating the free-riding problem in takeovers (see e.g., Grossman and Hart, 1980; Demsetz and Lehn, 1985 and Burkart, Gromb and Panunzi, 1997), they may also expropriate other  stakeholders by influencing management or deterring efficient takeovers to maintain their private control benefits (Stulz,1988). Empirical evidence about the effect of controlling shareholders, for example a founding family, on firm performance is also inconclusive (see Bertrand and Schoar (2006) who review the empirical studies on family ownership).

Amid the ongoing debate, we provide a new perspective on the role of controlling shareholders in the market disciplinary mechanism, and how it interacts with the firm’s potential synergy characteristics and internal governance mechanisms. While the use of performance pay and internal monitoring are easily justified by the extant literature, the disciplinary effects of the market for corporate control are less obvious. In many countries, there are debates about the social cost of concentrated ownership structures, and some regulators (e.g., the European Commission) have been advocating in favour of breaking up concentrated ownership structures to facilitate the market for corporate control and its managerial disciplinary function.

In contrast to this standard view, our analysis shows that the managerial disciplinary mechanism of synergistic takeover can be strengthened by the presence of controlling shareholders.  Furthermore, while the control premium required by controlling shareholders reduces the incidence of synergistic takeovers, the internal monitoring performed by these shareholders can complement the market disciplinary mechanism in high synergy potential firms.  Overall, it is ambiguous whether dismantling a concentrated ownership structure would increase firm value and, in particular, in firms which provide high synergy potential to acquirers.

Our analysis suggests that more sophisticated policies for the market for corporate control may improve the social welfare more effectively.

Controlling Ownership and Managerial Agency Problem

The managerial agency problem is relevant even when considering takeovers of family firms. Founders hold 15% of the CEO positions, 30% are held by descendants while the absolute majority of approximately 55% are held by professional managers (Villalonga and Amit, 2006). Bidders that operate in the same industry, for example, will be able to observe the state of demand to assess the synergistic improvements. In contrast, family owners are likely to be less actively involved in firm operations, and less informed about the industry/market situation, which suggests their lack of operational expertise vis-a-vis managers.

In the presence of potential conflicts of interest between the management and shareholders, the market for corporate control serves a disciplining role. Then why does the private benefit of controlling shareholders, which increases the takeover premium, strengthen this market disciplinary mechanism?

We argue that, notwithstanding their negative effect on the incidence of synergistic takeovers, the controlling shareholders can strengthen the managerial disciplinary effect of a takeover in firms that offer acquirers large business synergies.

To answer the question intuitively, suppose that the manager has no anti-takeover defense. In this case, the manager can secure herself from takeover threats only by increasing the market value of the firm, and, therefore, the takeover threat can discipline the manager. In firms which offer high synergy potential to the acquirers, however, the manager may find it too costly to increase the market value enough to deter a synergistic takeover. The control premium required by controlling shareholders can complement the market disciplinary mechanism in this circumstance, and, specifically, reduce the profitability of synergistic takeovers and make the acquirers’ bidding choice more sensitive to current market value. That is, it allows the managers of firms that offer high business synergies to reduce the takeover threat significantly by increasing the market value.

Technically, our model shows that the necessary and sufficient condition for the complementarity of ownership concentration and the market disciplinary mechanism is the log-convexity of the distribution function of potential business synergy. The market value increase from truthfully reporting the favorable state may, in itself, not significantly deter the takeover attempts for these firms since acquirers still find the business synergy more than offsets a high stock price. The control premium required by controlling shareholders makes truthful managerial reporting (and the corresponding market value enhancement) more effective in reducing the likelihood of a takeover. Specifically, the control premium increases the manager’s opportunity cost of misreporting and, in turn, it reduces the information rent that shareholders forgo to the manager.

Interaction with Other Governance Mechanisms

The analysis also provides implications for the relationship between ownership structure and other governance mechanisms, such as managerial compensation and the monitoring function of controlling shareholders.

Given that the managerial agency problem cannot be fully eliminated by the takeover threat and managerial compensation, the monitoring function of controlling shareholders can complement the other two governance mechanisms in our setting.

We show that the disciplinary effect of synergistic takeovers reduces the information rent paid to the manager and, thus, it diminishes managerial incentive pay. This implies that managerial pay-performance sensitivity is negatively associated with ownership concentration in firms which offer high business synergies. Furthermore, our analysis also shows that, in high synergy potential firms in which controlling shareholders strengthen the market disciplinary mechanism, monitoring function of controlling shareholders can complement the market disciplinary mechanism, and, thus, ownership concentration increases the operating efficiency relative to firms with dispersed ownership.


Contrary to the common prior, the disciplinary effect of synergistic takeovers can be stronger in high synergy potential firms with controlling shareholders due to improvements in incentives for managerial self-selection. Specifically, the control premium encourages the manager to deter the takeover threat by increasing the current value of the firm. In this case, managerial entrenchment is consistent with improvements in shareholder value.

The disciplinary effect acts as a complement to the internal monitoring efforts of controlling shareholders in reducing the amount of incentive pay required to induce managerial truthfulness. In contrast, the control premium in firms with few synergies isolates the manager from the takeover threat, making incentive provision reliant on internal monitoring.

However, the disciplining effect of synergistic takeovers is not without its costs, making the overall value implications ambiguous. Incentive provision requires that shareholders accept relatively low bidding prices, by allowing takeovers with negative synergies. Furthermore, tailoring correct incentive pay requires a relatively high distortion to effort levels in times of economic downturns. While controlling ownership is able to mitigate these concerns, the existence of a control premium also reduces the incidence of socially desirable synergistic improvements in firm value.

Overall, policy makers should take care when considering implementation of constraints on the controlling states in order to facilitate the market for corporate control.


  • Anderson, Ronald C., and David M. Reeb, 2003. “Founding-family ownership and firm performance: Evidence from the S&P 500”, The Journal of Finance, 58, 1301-1327.
  • Bertrand, Marianne, and Antoinette Schoar, 2006. “The role of family in family firms”, Journal of Economic Perspectives, 20, 73-96.
  • Burkart, Mike, Denis Gromb, and Fausto Panunzi, 1997. “Large shareholders, monitoring and the value of the firm”, The Quarterly Journal of Economics,112, 693.
  • Demsetz, Harold, and Kenneth Lehn, 1985. “The structure of corporate ownership: Causes and consequences”, Journal of Political Economy, 93, 1155-1177.
  • Grossman, Sanford J., and Oliver D. Hart, 1980. “Takeover bids, the free-rider problem, and the theory of the corporation”, The Bell Journal of Economics,11, 42-64.
  • Villalonga, Belen, and Raphael Amit, 2006. “How do family ownership, control and management affect firm value?”, Journal of Financial Economics, 80, 385-417.
  • Stulz, Renee, 1988. “Managerial control of voting rights: Financing policies and the market for corporate control”, Journal of Financial Economics, 20, 25-54.

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

When Fair Isn’t Fair: Framing Taxes and Benefits

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Taxes and benefits create incentives for people to adopt or avoid certain behaviours. They create premiums for (socially) preferred states. A premium can be determined by either taxing unwanted behaviour or by subsidizing desired behaviour. The resulting economic incentive for changing one’s behaviour is nominally equivalent under both mechanisms. However, the choice of frame for an incentive to be either described in terms of a tax or as a benefit can strongly influence perceptions of what is fair treatment of different, e.g. income, groups. Using a survey-experiment with Flemish local politicians, we show policy-makers to be highly susceptible to such tax and benefit framing effects.  As such effects may (even unintendedly) lead to sharply different treatment of the same group under the two mechanisms, important questions arise, particularly for the design of new tax and benefit schemes.

The design and implementation of redistributive policies usually evoke much discussion. Opinions, both in public and often also in political debate, tend to be driven by ethical and fairness considerations. However, such concerns can lead to unintended consequences and – at least in terms of ex-ante intended fairness – to ex-post imbalanced incentive structures for different (income) groups.

An important function of taxes and benefits is the creation of premiums for certain behaviours or actions. Either unwanted behaviour may be taxed and thereby sanctioned, or desired behaviour may be encouraged through benefits. Irrespective of the method chosen, an economic incentive is created for individuals to opt for the desired behaviour.

The way such premiums are defined can usually be thought of as a two-step process. First, a baseline for a given behaviour, action, or state is chosen as a reference-point. For instance, baseline behaviours could be to not have retirement savings, to not use safety-certified equipment or follow accepted standards at work, or to not have children. Arguably, these are cases warranting the creation of incentives to encourage people to adopt the socially desirable behaviours of saving money for their old age, working in a safe environment, and having children. The second step, then, requires a choice of mechanism to create an incentive. The mechanism can be to either punish the unwanted behaviour – such as not adhering to safety standards at work – or to grant (cost-reducing) subsidies and benefits for taking the desired action, such as saving for old age or having children.

Importantly, the combination of the chosen reference point and the mechanism to create the incentive can influence the way people think about the fairness of an incentive when the targets belong to different (income) groups. Schelling (1981) demonstrated this point in an in-class experiment, which, somewhat simplified, runs as follows:

Families typically receive some child benefit: they get a certain sum per child. Imagine there are two families, one poor and one rich, both with their first child. What amounts of child benefit should each family get? Should the poor get more than the rich, should both families get the same, or should the rich family get more for having a child than the poor family? Schelling’s students would tend to voice support for either the poor getting more or both families getting the same. After all the rich family is surely already affluent enough to support their child. At the extreme, the rich family would get nothing for having a child, and the poor family quite a lot.

Now think of a world where the standard is to have a child, and couples who do not have a child have this ‘socially undesirable’ behaviour ‘penalised’ through a fee, for instance in the form of a tax. Should the poor couple pay a higher fee, should both couples pay the same, or should the rich couple pay a higher fee? The students now overwhelmingly supported requiring the rich couple to pay more. After all, they have more disposable income. However, in this case, the rich couple receives a lot for having a child (they no longer need to pay the steep fee), whereas the poor family may get no (additional) economic incentive for having a child. The treatment of the same family thus obviously drastically differs between the two frames. At the extreme, the poor family gets quite a lot for changing from having no children to having one child in the first frame, but nothing in the second frame. For the rich family, the situation is the reverse: there is no premium for having a child in the first frame, but potentially quite a high premium for having a child in the second frame.

Does this thought-experiment matter outside the classroom (see also Traub 1999, McCaffery & Baron 2004), beyond the context of child benefit, and among those actually exposed to the design considerations of tax and benefit systems? In a recent paper (Kuehnhanss & Heyndels 2018), we test the occurrence of such framing effects with elected local politicians in Flanders, Belgium, who are involved in the budgetary decision-making in their municipalities.

Framing experiment

We invited 5,928 local politicians to take part in an online survey on economic and social preferences in spring 2016. Participation was voluntary, not incentivised, and questions were not compulsory, allowing respondents to skip them if they so chose. In total, 869 responses to the survey were registered and (N1=) 608 participants provided usable answers to the questions relevant to the framing effect described above.

Participants were randomly allocated to one of two groups, each receiving a slightly different wording of the following question:

“In Belgium couples receive financial benefits from the state. Suppose that it is not relevant how the transfer is funded, and ignore any other benefits, which might come into play. How much [more / less] should a couple [with their first child / without children] receive per month than a couple [without children / with their first child]?”

One group saw the question in the benefit frame with only the italicised phrases in the brackets displayed; the other group saw the question in the tax frame with only the phrases in boldface displayed. In both groups, participants were then asked to fill in amounts they would consider appropriate for each of three couples with different monthly net incomes: €2,000, €4,000, or €6,000, respectively.

With framing effects – and distinct from classic rational choice models – the expectation is that the three couples would be treated differently depending on the phrasing of the question. In the italicised benefit version the amount granted should be decreasing with the income of the family. In the boldface tax version the stated amount should be increasing with the families’ income.

Figure 1. Results child scenario

Source: Kuehnhanss & Heyndels (2018, p.32)

As Figure 1 shows, the results strongly conform to this pattern. The low-income (€2,000) couple is granted an average of €330 in the benefit frame, but only €178 in the tax frame (recall that the premium in the latter arises from no longer receiving less – or ‘paying a fee’ – once there is a child). For the high-income (€6,000) couple, the amounts granted average €132 in the benefit frame, but a much higher €368 in the tax frame.

Environmental taxes and benefits

Child benefit systems are usually a well-established part of countries’ tax and benefit systems. The design of new instruments is more common in policy areas undergoing, for instance, technological change or being newly regulated. A relevant example is policy on the promotion of environmentally friendly behaviour and technologies, e.g. through ‘green’ taxes and subsidies. To test the validity of the hypothesised framing effect, we also included a second scenario in our survey related to the municipal interests of our respondents, namely car taxes. Flemish municipalities receive income from a surcharge levied on the car taxes paid by motorists. Consequently, we asked our participants (N2 = 525, see the paper for details) to imagine the introduction of a new environmental certificate for cars in Belgium, and to provide amounts they would consider appropriate for the difference in annual tax paid on cars with or without the certificate. Specifically, roughly one half of participants was asked how much less the owner of a certified car should have to pay in annual car tax than the owner of a non-certified car (the subsidy frame). The other half was asked how much more the owner of a non-certified car should pay in annual car tax than the owner of a certified car (the tax frame). The question was again asked for three different levels, proxying wealth via the cost of the cars: €15,000, €30,000, and €45,000, respectively.

Figure 2. Results car scenario

Source: Kuehnhanss & Heyndels (2018, p.32)

Figure 2 shows the results. The effect is less pronounced in this scenario, as the slope for the granted amounts in the subsidy frame remains largely flat or slightly increases. Nonetheless, a substantial framing effect remains. In the tax frame, the amount of the premium (i.e. the amount of taxes no longer owed once a certificate is obtained) strongly increases with the cost of the car. Taking the most expensive car (€45,000) as an example, we thus observe differential treatment across frames also in this scenario. In the subsidy frame, the premium for having a certificate is €778, in the tax frame it is a much higher €1,333.


These results suggest a strong and economically meaningful effect of framing among policy-makers with a stake in tax and benefit systems. While the exact mechanism driving the results invites further research, the strongly divergent premiums, and hence distribution of incentives, across baseline frames raise concerns of unintended effects in the design of taxes and benefits. Especially new schemes – e.g. ‘green’ policy, reform, or regulatory expansion – may benefit from increased scrutiny in the design process. Awareness of susceptibilities to framing and its potential influence on the formulation of individual tax and benefit instruments may help to align intended fairness, incentive structures, and redistributive outcomes.