By Jeffrey W. Allen and Gordon M. Phillips

We examine the determinants of the magnitude of corporate equity ownership stakes and the operating performance of firms surrounding the establishment of these large ownership positions by non-financial corporations. We explore the possible motivations and benefits of these stakes and examine whether product market agreements and alliances with corporate owners are important in understanding the motivation for corporate ownership stakes. Our sample consists of 402 firms where corporations hold a minimum of five percent of outstanding shares and the stake is held for a minimum of two years. Thirty-seven percent, or 150, of the target firms in the sample have explicit business relationships with their corporate blockholders.

We find evidence of improvements in operating performance in cases where the purchasing and target firms are involved in joint ventures or other business alliances. Second, we find that the magnitude of ownership stakes is significantly related to measures of asset specificity and Tobin’s q for firms that have business alliances with their corporate owners. These results are strongest for firms with sufficient internal financing to fund the next two years of capital expenditures and R&D. Third, for these firms, we find that the sensitivity of investment to Tobin’s q significantly increases. Fourth, we find a strong association of investment with Tobin’s q for firms in which there is repeated interaction through supply and distribution agreements between the firm and its equity owner. These significant findings for firms with sufficient internal capital to fund subsequent investment are evidence that these equity purchases are not used merely to fund future investment.

Overall, the results suggest that corporate equity ownership plays an important role in business relationships between firms. The evidence is consistent with the view that an equity position by an outside corporation is important in aligning incentives between contracting firms to expand joint investment opportunities and reduce the costs of generating and maintaining business agreements and alliances.

 Download the Paper: http://www.mbs.umd.edu/finance/gphillips/papers/equity.pdf