Ownership, Control and Corporate Valuation of Brazilian Companies Ricardo Leal (COPPEAD/UFRJ) André Carvalhal (COPPEAD/UFRJ) Sílvia Valadares (Min. Planejamento) Jairo Procianoy (PPGA/UFRGS)

Introduction l Objectives: analyze the control structure of Brazilian companies and its effect on corporate valuation l Presentation structure: n Data and methodology n Direct shareholding composition n Indirect shareholding composition n Control & Value n Conclusion

Hypotheses  Higher concentration of voting rights is associated with more expropriation  Higher expropriation is associated with lower corporate valuation  Therefore: Higher concentration of voting rights is associated with lower corporate valuation.

Data l Companies listed on the São Paulo Stock Exchange (Bovespa) that are not controlled by the Government l Year-end 1998 l Sample: 225 firms, representing 70% of the Bovespa market capitalization including government-controlled companies, and more than 90% of the Bovespa market capitalization excluding government-controlled companies.

Methodology l Two forms of shareholding composition: direct and indirect l We consider all shareholders with 5% or more of the voting capital l Information on the shareholding structure collected from the Infoinvest database l All 225 companies were divided into two groups: firms with a majority shareholder (more than 50% of the voting capital) and firms without a majority shareholder

Control Groups l For the companies with one majority shareholder: n If there is an indirect control structure (pyramid): –shareholder does not maintain control indirectly –shareholder maintains control indirectly: l by increasing its share of the voting capital l by maintaining the same interest l by decreasing its share in the voting capital n there is no indirect control structure

Control Groups Is there a majority shareholder Is there a pyramid? No. Stop. Does shareholder keep control? No. Stop. IncreaseSameDecrease

Direct and Indirect Control l Firms with a controlling shareholder: n largest has 74% of the voting capital directly and 55% indirectly, on average n 3 largest have 87% of the voting capital directly and75% indirectly l In firms without a controlling shareholder the difference between direct and indirect control is minimal.

Direct Shareholder Composition l Large degree of concentration of voting capital l Reasonable difference between the percentage of voting and total capital held by large shareholders, voting rights are not the same as cash flow rights l The issuance of non-voting shares appears to be used by large shareholders to maintain control of the firm without having to hold 50% of the total capital

Direct Shareholder Composition

Indirect Control l If controlling shareholders make full utilization of the 2:1 non-voting to voting shares proportion to minimize their investment then, indirectly, we should expect to see these shareholders with a proportion of 17% or less of the voting capital

Computing Share of Capital l If a shareholder has 50% of a company that has 50% of another, then his or her indirect share of the total capital is 50% times 50% or 25%. l The same criteria is used to compute the share of the total capital owned by controlling shareholders

Indirect Shareholder Composition

Comments on Indirect Control l Total capital participation of major shareholders is much higher than 17% l This suggests that the utilization of pyramids as a mechanism to maintain control with less investment is not very common in Brazil l Therefore, there may exist private benefits of control, potentially by the expropriation of minority shareholders

Indirect Majority Shareholders

Indirect Control l Of the 121 companies where there is a majority direct shareholder and where pyramids are used, in 53 the major shareholder does not maintain control indirectly, while they do in 68 l In the 68 firms where they maintain control indirectly, in 15 cases they concentrate their voting power, in 17 they keep it and in 36 they diversify

Measuring Value l Tobin’s Q and industry adjusted Tobin’s Q l Price-to-book value (P-B) and industry adjusted P-B l Beta and industry adjusted beta to account for risk l We conduct an ANOVA and a differences in means test in order to compare the expropriation measures among the six groups of companies

Value and Control l Value seems to be lower for firms where control is kept indirectly l Value seems to be lower for firms where control is not only kept but increases indirectly compared to the greater value of firms where the share of control is kept but decreases indirectly l Lower valuation for indirect concentration of the voting share is consistent with potential minority shareholder expropriation

Measuring Expropriation (1996)

Measuring Expropriation (1998)

Conclusion l Large degree of concentration of the voting capital in Brazilian companies in 1998 l Reasonable difference between the percentage of voting and total capital held by large shareholders l The utilization of a pyramid structure does not appear to be an effort to avoid the one share- one vote rule in Brazilian companies. l Lower valuation for companies where private benefits of control are needed the most