CORPORATE OWNERSHIP STRUCTURE AND FIRM PERFORMANCE
	IN SAUDI ARABIAt
Dr. Yakubu Alhaji Umar Dr. AU Habib AI-Elg Department of Finance & Economics King Fahd University oCPetroleum & Minerals Dhahran, Saudi Arabia
Abstract
The empirical results of this study suggest that corporate ownership structure has a significant effect on firm performance. Previous studies focus solely on US firms. This study is based on all publicly traded firms on the Saudi stock market. More generalized insights into the relation between ownership structure and firm performance are obtained by examining the performance of Saudi firms using ROE as a proxy for firm performance. The results show that Government Ownership (GO) and Foreign Ownership (FO) have statistically significant impact on firm performance as measured by ROE:
Introduction
This paper examines the effect of corporate ownership structure and firm performance using ROE as a measure of performance. Following Jensen and Meckling [1976]) interest in the relation between firm performance and the allocation of shares among shareholders has continued to evolve in the finance literature. According to Jensen and Meckling [1976]) managers have the tendency to allocate firn1's resources in their own best interests. This behavior may conflict with the interests of outside shareholders. As managers' equity ownership increases) however) their interests coincide more closely with those of outside shareholders) and hence the conflicts between managers and shareholders are likely to be resolved. Thus) management's equity ownership helps resolve the agency problems and improve the firm's performance. However) several studies suggest that management's ownership does not always have a positive effect on firm performance. Fama and Jensen [1983] demonstrate that managers who own enough stock t9 dominate the board of directors could expropriate corporate wealth. Large-block shareholder could) for example) pay himself an excessive salary) negotiate deals with other companies he controls) or invest in negative-net-present-value projects. Stulz [1988] yxplains how owning large blocks makes it easier for managers to be entrenched. Thus) greater stock ownership by managers increases the owner of the internal constituency) but decreases the power of the external ponstituency in influencing corporate perfonnance.
Berle and Means [1968] argued that the separation of owner and manager found in the jointstock firm form of corporation created situations where the interests of owners and m~nagers
./
The authors grarefully acknowledge support provided by the King Fahd University of
Petroleum and Minerals through the College of Industrial Management Research Grant
seheme.	,.. /
357

.-'
...",.......
might differ. The shareholder owner often held equity in a number offin1'ls and chose not to take an active role in the management of anyone firm but hire professional managers to direct firm activity. Because of their ability to diversify their overall financial risk through portfolio investments, the shareholder owner is likely to prefer that the individual firms take riskier actions
that maximize their wealth. Thus, the separation of ownership and the diversification potential of owners create two problems. First, the interests of owners and managers will often tend to differ. in terms of risks and benefits. Second, managers may possess information not readily available to owners and are in a position to use their control of information to justify or support actions that
are jn their interest but not the firm as a whole including shareholders.	.
"
The objective of this paper is to examine the effect of corporate ownership structure on firm performance. Specifically, this paper examines the effect of Government and Foreign Ownership on firm performance which has not been studied in extant literature. We seek to investigate the relation between ownership structure and firm performance using Saudi firms" sample. This research uses Saudi data which includes 67 firms, an emerging market in the Middle East instead
of focusing on U.S. firms. We use return on equity as a measures ,of firm performance instead of
short-term stock returns which are t60 volatile to be used as a reliable measure of corporate
performance since long term returns will capture corporate performance more effectively. This paper is structured as follows. Section II reviews the previous literature. Section III describes the data and research methodology. Section IV presents the empirical results. Section V concludes the paper.
II	Literature Review
Morch, Shieifer, and Vishny [1988], and McConnell and Servaes [1990], among others, empirically examine the effect of ownership structure on corporate performance. Morch, Shleifer, and Vishny [1988] estimate a piece-wise linear regression in which the dependent variable is Tobin's q ratio [1969] as a proxy for: corporate perfonnance, and the primary independent variable is the fraction of shares owned ;by corporate insiders. While these studies
do not agree on details, they both report that the relationship between q ratio and the degree of
insider ownership is not linear: in some range of insider ownership, q ratio is positively related to insider ownership, but in other range, a negative relationship is found. Thus, the results of these studies suggest that insider ownership does not always have a positive effect on corporate performance. Using a different methodology, McConnell and Servaes [1990] also demonstrate that q ratio is nonlinearly related to the degree of insider ownership. Interestingly, McConllell and Servaes show that q ratio is positively related to the degree of institutional ownership, indicating a positive effect of institutional ownership on corporate performance. They suggest that managers' entrenchment would be more difficult with the existence of institutional shareholders.
Jensen and Meckling [1976] in their seminal research on corporate governance triggered a large body of theoretical ,.and empirical researches that are largely focused on U.S. based corporate governance in""the' 1980s. By the early I 990s, however, research on corporate governance focused primarily on other major world economies such as U.K., Germany and Japan. More recently, there has been an explosion of corporate gov;l11ance research around the world.
358
----
-
--

- --
Holderness [2003] surveys the U.S. evidence on equity ownership by officers and directors of a finn and block holders that own at least 5% of the finn's equity. He reports that the average inside ownership in publicly traded U.S. corporations is approximately 20%, varying from almost none in some finns to majority ownership by insiders. In another survey, Holderness [2003] examines the effects of management and blockholder equity ownership 011 corporate decisions and on finn value and finds opposing results about the effects. The U.S. evidence regarding the effects of ownership structure on corporate decisions and on finn value is mixed. Morck, Shleifer and Vishny [1988] and McConnell and Servaes [I990] find that the aligrunent effects of inside ownership dominate the entrenchment effects over some ranges of managerial ownership. However, as inside ownership increases beyond some level, the entrenchment effects of inside ownership dominate and higher inside ownership is associated with lower finn value. In contrast, Himmelberg, Hubbard and Palia [1999] use panel data and conclude that a large fraction of the cross-sectional variation in managerial ownership is endogenous. They suggest
that managerial ownership and finn performance are determi"ned by a common set of characteristics and, therefore, question the causal link from ownership to performance implied by
previous studies.	I
Beginning in the late 1990s, studies of equity ownership concentration expanded to include countries from the emerging markets. This body of evidence reveals that concentrated ownership
structures are more typical of ownership structures around the world than are the relatively'
diffused structures observed in large, publicly traded U.S. and U.K. finns. This generalization, however, masks important differences across countries with respect to the degree of ownership concentration and the identities of the blockholders. Faccio and Lang [2002] in their European studies conclude that listed firms. are generally either widely held, which is more common in the U.K. and Ireland, or family owned whic/1 is more common in continental Europe. Xu and Wang [1997] document high ownership concentration in China, with ownership split relatively equally between the government, institutions, 'and domestic individuals. Valadares and Leal' [2000] document high ownership concentration in Brazil; with the majority of blockholders being corporations or individuals.
Numerous other studies address the relationship between. ownership structure and finn perforn1ance. Kang and Shivdasani [1995] find that Japanese firn1s with blockholders restructure more quickly following perfonnance declines than do Japanese finns without blockholders. They point out, however, that the response comes less quickly in Japan than in the U.S. Gordon and Schmid [2000] document that finn performance in Germany is positively related to concentrated equity ownership. There are numerous potential types of large shareholders: other corporations, institutions, families and government. The evidence impHes that the relation between large shareholders and value often depends on who the large shareholders are. Claessens, Djankov, Fan, and Lang-[2000], for example, examine finns in nine East Asian countries and find that the impact of owner~t~jp..yaries according to the identity of the block holder. They conjecture that ownership by corporations is negatively related to performance, while ownership by. the government is positively associated with perfonnance. They find 110 relation between institutional ownership and finn performance. Gibson [-2003] studies firms in eight emerging markets and reports that, while CEO turnover is likely for poorly perfonning finns in the s~inple
359

~t1If/"-
overall, there is no relation between CEO turnover and firm performanee(or the subset of firms
that have a large domestic shareholder.	.
The evidence from around the world indicates that the relation between ownership structure and firm performance varies by block holder identity. Overall, however, this body of evidence suggests that there is a more significant relation between ownership structure and firm performance in U.S. firms. We are interested in finding whether or not ownership structure has a positive effect on firm performance in Saudi Arabia.
III
Data and Research Methodology
"
The sample data on stock ownership is obtained from the 2003 Bakheet Financial Advisors and 2003 Saudi Stock Market Guide published by the Saudi American Bank (SAMBA) consisting of
the 67 Saudi firms. We checked the same data from other sources including 2002 Middle East Economic Digest (MEED) to verify the information on the 67 Saudi firms. We selected and classified the firms as Government-Controlled (qO), Foreign-Controlled (FO), OwnerControlled (OC) or Manager-Controlled. GO, FO and OC status. was assigned to firms if the largest shareholder owned 20% or more of the voting common stock. Conversely, MC status was assigned to firms if no single holding of stock is gr~ater than 5% of the outstanding common stock. This control criterion was used by Berle and Means [1968], Elliot [1972], Karnerschen [1968}, Lerner [1966] and Sorenson []974]. The return on equity during a 2-year period [20012002] is adopted as the appropriate measure of a firm's performance. The effect of ownership structure on performance was evaluated through regression methodology. We adopt a regression approach to control for other potentially influencing factors.
We used cross-sectional data for a two-year period (200] through 2002) to examine .the relationship between ownership structure and firm performance. We consider this time period to be sufficient in length to enable us identify the relationship between ownership control and the firms' financial characteristics. In fact, this shorter test period minimizes measurement errors over longer periods due to changing firm risk and common stock ownership positions in Saudi Arabia.
IV Empirical Results
We adopt ROE as a measure of firm performance since ROE is the accounting ratio often used to measure the effective performance of management. In order to assess the impact of corporate ownership structure on firm performance; we use the following regression model:
ROE = a. + ~I GO + ~2 Fa + e	1
ROE = Return on Equity
GO = Government Ownership
Fa = Foreign Ownership
360

Table 1: Effect of Corporate Ownership Structure on Firm Performance:
	, Regression Results
2001
!
ROE = a'+ PI GO + P2 FO + e
F-value = 7.18	Sig. = 0.002
ROE = .0~91 + .I40(GO) + .441 (FO) t-values' (2.282) (3.260)
2002
F-value ='8.351	Sig. = .001
ROE = 0.02926 + 0.07521 (GO) + .214(FO)
t-values	(2.463)	(3.218)
This model is estimated using two series of cross-sectional data for 2001-2002 in order to assess the consistency of the results across these two sub-periods. The results of estimating equation (l) are summarized in Table 1. These results based on 200 I data reveal that the model is statistically significant at .002 level (F-value= 7.18). Both GO and FO have statistical significant impact on ROE at .026 and .002 level of significance respectively. The analyses of 2002 data reveals that GO and FO have statistical significant impact on ROE at .016 and .002 level of significance respectively. These results are consistent across the two test periods. The model suggests that corporate ownership structure has strong effect on firm performance in, Saudi Arabia.
The results suggest that FO has positive effect on firm performance possibly due to the managerial efficiency and technical skills as well as the state of technology that foreign owners bring to their work environment. Given that the Saudi Government is contemplating to join WTO in the near future, the results imply that Government policies with regards to foreign direct investment should be further relaxed to attract foreign investors into the Country. These changes in the private sector would promote efficiency and contribute to growth in the economy. The positive impact of GO on Saudi firm performance may indicate that firms in which government have ownership enjoy natural or legalized inonopolistic powers. Additionally, government often instructs their agencies to procure their needs from firms in, which the government has ownership.
V Conclusions
I
Does corporate ownership structure (GO and FO) impact firm performance? The answer to this
question is yes based on the statistical iesults of this study. The positive impact of FO on performance is not too surprising since the foreign owners employ efficient management practices and us~ state of the art technology, both of which enhance performance. The implications of the $Sults'suggest that FO and GO have positive impact on the ROE and hence the firm performance. In cOl1trast, the positive impact of GO on performance is somewhat surprising. This can be partly explai11ed by the monopolistic nature of the sectors in which the govemment has stake. To develop more generalized irfsights into the effect of corporate
'..
361
- - - -

~_.
ownership structure on firm performance, we need to expand the doma1n of the study into the
Gulf Cooperation Council (GCC) nations.	.
References
Berie, A. A., and G. Means [1968], "The Modern Corporation and Private Property." Rev. Ed., New York: Macmillan Publishing Company, Inc., Corporate Data Exchange, Inc. CDE Stock OWnership Directory -Fortune 500 No.5, New York. 1981.
Claessens, S., S. Djankov, J. P. H. Fan, and L. H. P. Lang [2000] "The Separation of Ownership and Control in East Asian Corporations." Journal of Financial Economics, 58, 81-112.
Diane K. Denis and John J. McConnell [2003], "International Corporate Governance", Journal of Financial and Quantitative Analysis, vol. 38, I, 1-36 March.
Elliot. J. W. (1972), "Control, Size, Growth, and FiJ)ancial Performance in the Firm." Journal of Financial and Quantitative Analysis, 7, I (January), 1,1309-20.
Facio, m. and L. H. P. Lang [2002], "The Ultimate Ownership of Western European Corporations." Journal of Financial Economics, 65, 365-396.
Fama, Eugene F., and Michael C. Jensen. "Separation of Ownership and Control," Journal of Law and Economics, 26 (June 1983): 327-349.
Gibson, M. S. [2003], "Is Corporate Governance Ineffective in Emerging Markets?" Journal of Financial and Quantitative Analysis, 38, 231-250.
Gordon, G., and F.A. Schmid [2000], "Universal Banking and the Performance of German Firms." Journal of Financial Economics, 58, 28-80.
Himmelberg, C. ,p., Hubbard, R. G. and D. Palia [1999], "Understanding the Determinants of Managerial Ownership and the Link between Ownership and Performance." Journal of Financial Economics, 53, 353-384.
Holderness, C.G. [2003], "A Survey of Blockholders and Corporate Control." Economic Policy Review, vol. 9 no. 1, April, pp. 51-64.
Jensen, M. and W. Meckling [1976], "Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure." Journal of Financial Economics, 3, pp. 305-360.
Kamerschen, D. ~...{.J.96If], "The Influence of Ownership and Control on Profit Rates." American Economic Review, 58, 3 (June), 432-47.
Kang, . J., and A. Shivdasani [1995], "Firm Performance, Corporate Governance and Top
	"
Executive Turnover in Japan." Journal of Financial Economics, 38, 29-58.	~
362
--
- -----

Ki C. Han, Suk Hum Lee and David Y. Suk [1999], "Owm;.rship- Structure and Firm Performance: International Evidence", Multinational Business Revkw, vol. 7, I spring, 92-97.
Lamer: R.J. [1966], "Ownership and Control in the 200 Largest Non-Financial Corporations, 1929 and 1963". American Economic Review 55, 4 (September), 777-87.
McConnell, John J. and Henri Servaes [1990] "Additional Evidence on Equity Ownership and Corporate Value," Journal of Financial Economics 27: 595-6 12.
Morek, Randall, Andrei Shleifer, and Robert W. Vishny [1988], "Management, Ownership and Market Valuation: An Empirical Analysis," Journal of Financral Economics, 20 (January/March) 293-315.
Sorensen, R., [1974], "The Separation of Ownership and Control and Firm Performance: An Empirical Analysis." Southern Economic Journal, 41, 1 (July), 145-51.
Stulz, Rene M. [1988], "Managerial Control of Voting Rights: Financing Policies and the Market for Corporate Control," Journal of Financial Economics, 20 (January/March): 25-54.
Valadares, S. M., and R. P. C. Leal [2000], "Ownership and Control Structure of Brazilian Companies." Working Paper, Un.iversidade Federal do Rio de Janeiro.
Xu, X., and Wang, Y. [1997], "Ownership Structure, Corporate Governance, and Finns' Perfonnance: The Case of Chinese Stock Companies." Working Paper, World Bank.
363