OWNERSHIP, CONTROL, FINANCIAL

STRUCTURE AND THE PERFORMANCE

OF FIRMS
Helen Short
Universit y of Leeds
Abstract. The notion that the separation of ownership from control may
create a divergence of interests between managers and shareholders has led
to a large number of studies which investigate the influence of ownership
structures upon a firm’s financial structure and its performance. The purpose
of this paper is to review and critically evaluate the literature that
empirically analyses the effects of ownership and control structures on both
the financial structure and the performance of the firm. In addition, further
consideration is given to the dynamic relationships between ownership,
control, financing and firm performance.

Keywords. Ownership; control; performance; financial structure.

Introduction
The hypothesis that modern corporations are characterised by the separation of
ownership and control, as first proposed by Berle and Means (1932), has led to
a body of literature, both in the US and in the UK, examining the effects and
significance of the ownership and control structure of the firm on its
performance and financial structures. The notion that differing ownership and
control structures have significant implications for the operation and
performance of the firm is in contrast with the neoclassical economic theory of
the firm, which views the firm as, ‘a “black box” operated so as to meet the
relevant marginal conditions with respect to inputs and outputs, thereby
maximizing profits, or more accurately, present value’ (Jensen and Meckling,
1976, pp. 306—307). Neoclassical theory makes no attempt to model the
behaviour of the participants in the firm. The utility functions of the owner (the
risk-bearer) and the manager (the risk-taker) are synonymous as owner and
manager are the same person. However, the diffusion of share ownership, which
leaves managers of firms in effective control of operations would be expected to
have implications for the validity of the profit-maximizing goal, as managers
may pursue their own interests to the detriment of other shareholders. The
separation of ownership from control may, therefore, have behavioural
implications for the theory of the firm.
Managerial theorists argue that the separation of ownership from control
allows managers to pursue their own objectives at the expense of the
maximization of shareholder wealth. Therefore, con0ict may arise between the

0950-0804/94/03 0203—47 JOURNAL OF ECONOMIC SURVEYS Vol. 8, No. 3

fi Basil Blackwell Ltd. 1994, 108 Cowley Rd. , Oxford OX4 1 JF, UK and 213 Main St, Cambridge,
MA 02142, USA.
204 HELEN SHORT

objectives of the shareholders and the objectives of the managers of the firm.
The nature and extent of this con0ict will depend on the extent to which
ownership and control are separated and on the differing objectives and
incentives facing managers and shareholders. Consequently, the performance of
firms may be expected to differ depending on the presence and extent of the
separation of ownership from control.
Although Berle and Means (1932) sought to establish the existence of the
separation of ownership and control, ' they did not specifically examine its
implications for the behaviour of firms. However, the development of
managerial theories of the firm led to models based on managerial utility
maximization and consideration of the implications of managerial objectives on
firm behaviour [see, for example, Baumol (1959, 1962) and Williamson (1964)] .
The more recent principal-agent literature considers the problems of
information asymmetry and its effects on the actions of principals
(shareholders) and agents (managers).
Various arguments have been put forward, both supporting and opposing the
notion that the type of ownership structure will have significant implications for
the operation of the firm. Managerial theorists, such as Williamson (1964),
argue, in support of the notion, that the opportunity for management discretion,
as a result of the separation of ownership and control, will lead to managers
using shareholders’ resources to operate the firm in their own interests.
Management controlled firms should, therefore, be less profitable than owner
controlled firms due to the non-profit maximizing behaviour of non-owner
managers. Morris (1964), for example, assumes that managers maximize the
growth of the firm in order to maximize their own utility functions. Therefore,
management controlled firms are hypothesized to have higher growth rates and
lower profit rates than owner controlled firms. In addition, Baumol (1959) and
Monsen and Downes (1965) argue that, in management controlled firms, there
exists asymmetry in the management reward structures. Essentially, managers
are affected adversely by poor performance, but are unlikely to be excessively
rewarded for good performance. Furthermore, exceptionally good performance
in one year may raise the expectations of shareholders which managers may be
unable to meet in future years. As a result, management controlled firms are
predicted to be more risk averse and should yield lower risk and variability
measures than owner controlled firms.
Alternatively, opponents of this view argue that managers are effectively
constrained from taking actions that are not in the best interests of
shareholders, via several disciplining mechanisms, such as the threat of
takeover, bankruptcy and managerial labour markets. Fama (1980), for example,
argues that competition in the managerial labour markets will limit managerial
discretion and that the presence of outside directors on the board may act to
constrain management behaviour. Others suggest that the interests of managers
and shareholders can be aligned through either management ownership of the
firm [e.g. Lewellen (1969), Jensen and Mackling (1976), Benston (1985)] or
executive compensation packages, which link some measure of firm
performance to
Basil Blackwell 1994
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