Estimating the Effects of Large Shareholders Using a Geographic Instrument

In our paper, Estimating the Effects of Large Shareholders Using a Geographic Instrument, forthcoming in the Journal of Financial and Quantitative Analysis, we develop and test a new instrumental variable framework which allows us to separate selection effects from treatment effects for a large group of blockholders and to quantify their impact on several aspects of firm behavior. We start by documenting that non-managerial individual shareholders hold blocks in firms that are headquartered close to where they live. We then use this empirical fact to create an instrumental variable (the geographic variation in the density of wealthy individuals) for the presence of a large shareholder in a publicly traded U.S. firm. This instrument predicts the presence of a block in a firm with surprising power, and it is robust to the inclusion of variables that vary geographically, reducing concerns about its validity.

Our evidence contributes in three ways to existing research on blockholders and more generally to corporate governance research. First, we find that blocks are not randomly allocated to firms, but are systematically allocated based on where the benefits to additional monitoring are more significant. This result confirms a suspicion about block ownership endogeneity that researchers have had at least since Demsetz and Lehn (1985). Importantly, the non-randomness of blocks matters. The inferences about the impact of large shareholders change significantly once we control for selection effects….(continue reading)


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