Protecting Minority Shareholders and Developing Better Financial
Markets Research by Luigi Zingales
U.S. corporate scandals such as Enron and Tyco have highlighted
the fact that insiders enjoy benefits above and beyond those
of the average shareholder-the so-called "private benefits
of control." How widespread are these benefits? What effects
do they have on the development of a country's securities market?
Furthermore, how can such benefits be curbed? New research indicates
that in spite of the recent corporate scandals in the United
States, other countries face much greater hurdles in curbing
these private benefits, and in developing effective systems
of corporate governance.
The enormous executive perks uncovered in last year's Enron
and Tyco scandals brought mass media attention to something
corporate finance scholars have been saying for decades: not
all shareholders are created equal. Whoever is in control not
only enjoys the "psychic value" of control, but also
many unique privileges. For an extreme example, one need only
consider Russian oil companies, where insiders divert a large
fraction of profits by selling some of their oil to their own
companies at a price below market. While some private benefits
are clearly illegal, most venture into a gray area of borderline
illegal activities. It is a country's overall corporate governance
system that determines how easy it is for insiders to exploit
minority shareholders. Hence, the size of private benefits is
a good indicator of the efficiency of a country's corporate
How Are Private Benefits Measured?
Private benefits are inherently difficult to measure because
a controlling party is able to use corporate resources to his
or her benefit only if it is difficult or impossible to prove
these actions in court.
In a recent study, "Private Benefits of Control: An International
Comparison," Luigi Zingales, a professor at the University
of Chicago Graduate School of Business, and Alexander Dyck of
Harvard Business School overcome the problem of quantifying
private benefits by examining the price a controlling shareholder
pays for control. Their measure is based on the premise that
if control guarantees special privileges, the acquirer of a
controlling block in a publicly traded company should be willing
to pay for it. The difference between the price per share paid
for a controlling block, and the price that prevails on the
market, reflects the present value of the benefits enjoyed exclusively
by the controlling shareholder.
By examining 393 transactions in which a controlling block
of a company was sold in a study of 39 countries, Zingales and
Dyck find that, on average, corporate control is worth 14 percent
of the equity value of a firm. Their estimates of the value
of private benefits of control ranges from -4 percent of firm
value in Japan to +65 percent of firm value in Brazil.
Countries with high private benefits include Argentina, Austria,
Brazil, Columbia, the Czech Republic, Israel, Italy, Mexico,
Turkey, and Venezuela. At the other extreme are countries where
private benefits are 3 percent of equity value or less, including:
Australia, Canada, Finland, France, Hong Kong, Japan, the Netherlands,
New Zealand, Norway, Singapore, South Africa, Taiwan, the United
Kingdom, and the United States.
Hindering the Development of Financial Markets
Should countries with high private benefits worry? Zingales
and Dyck suggest that the answer is yes, because extensive private
benefits hinder the development of financial markets. In countries
with a higher degree of private benefits, entrepreneurs will
be more reluctant to take their companies public, and if they
do, they are likely to retain a controlling stake. As a result,
fewer companies will go public, and the equity markets in such
countries will be underdeveloped. This pattern makes it more
difficult for young companies to access financing.
Countries with high private benefits also are likely to have
more concentrated ownership. Such concentration is likely to
continue in the face of massive privatization, because in these
countries the government will find it convenient to sell the
controlling blocks via private negotiation, rather than issuing
shares in the public market.
Curbing Private Benefits
"One of the goals of our research is to understand what
can be done to curb private benefits and improve these underdeveloped
markets," says Zingales.
To examine this question, Zingales and Dyck undertake a systematic
analysis of what factors are associated with low private benefits
of control. The authors take note of traditional mechanisms
(such as legal protection of minority shareholders), but they
also explore the effects of alternative mechanisms for keeping
controlling shareholders in check. For example, they argue that
a combination of an inquisitive, independent press and a large
set of educated investors can be a powerful sanction on improper
The authors find that lower levels of private benefits of control
are associated with a high degree of legal protection for minority
shareholders, a high degree of law enforcement, a high rate
of tax compliance, greater diffusion of the press, and a high
degree of competition in the market for a company's products
In what is their most important new finding, Zingales and Dyck
document the role of corporate tax enforcement in reducing private
benefits. Tax claims make governments a de facto minority shareholder
in all publicly traded companies. As for minority shareholders,
the government has an interest in ascertaining the value produced
by a company. Transfer pricing, for instance, is disciplined
by the tax code. In the United States, transfers between related
corporate entities are supposed to take place at the price the
two units would have charged in a competitive market. Hence,
how tax authorities enforce their rules on transfer pricing
affects how much incentive insiders may have to transfer profits
to related companies. The stricter the enforcement, the less
likely it is that a controlling shareholder will use transfer
prices to siphon off value at the expense of minority shareholders.
Unlike minority shareholders, however, governments have the
incentive to enforce these laws even when the cost of prosecution
is higher than the money recoverable. By aggressively prosecuting
a company, governments can set an example that induces the corporate
sector to stay in line. Once income has been established for
tax purposes, it is much more difficult for insiders to divert
it to themselves. Therefore, a better tax enforcement system
can play an important role in reducing the private benefits
Leveling the Playing Field
"Our research indicates that the fastest road to financial
development is improving a country's corporate taxation system,"
Lower rates and greater enforcement can significantly reduce
the amount of private benefits and make investing a fairer process.
In the meantime, however, investors have many reasons to be
cautious. "When you buy a share in a country that has high
private benefits of control, you don't really know what you're
buying," says Zingales. "In certain countries, a large
percentage of a company's value can be easily appropriated by
the controlling shareholders."
In markets where private benefits are large, control will tend
to go to companies that are skilled at taking advantage of these
benefits. This represents a comparative disadvantage for U.S.
companies abroad. Reducing private benefits will help level
the playing field.
"Don't expect all countries to look like the United States,"
says Zingales. "In spite of cases like Enron, control is
much more valuable in other countries-a fact that managers and
policymakers need to recognize."
Luigi Zingales is Robert C. McCormack Professor of Entrepreneurship
and Finance at the University of Chicago Graduate School of