The Relationship Between Ownership Structure, R&D and Firm Innovative Performance:

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Master’s Thesis Business Administration - Strategic Innovation Management

The Relationship Between Ownership Structure,

R&D and Firm Innovative Performance:

A European perspective

By: Rico Plomp

Student number: 1913565

10 February 2014

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PREFACE

I would like to make use of this opportunity to thank some people that have been of great importance for the end result here in front of you.

Firstly, my supervisor, Dr. F. Noseleit, was always willing to help me out when I needed assistance or feedback.

Secondly, Pim van de Laar, who provided me with some advanced Excel tips and tricks to quickly and carefully sort the pile of data I had collected. Thirdly, I would like to thank my Strategic Innovation Management colleagues and friends for the great year.

Lastly, my friends and family who have been very supportive and interested in my progress during the past few months.

Enjoy reading my thesis,

Rico Plomp

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ABSTRACT

This research considers the relationship between ownership structure, R&D (input) and firm innovative performance (output) in Continental Europe, the UK and Europe overall. Until recently, these have mainly been studied in an Anglo-Saxon context, and never all three combined. This research joins the recent trend to take Europe as region of study. Based on the fundaments of agency theory and stewardship theory I develop and test a triangular shaped conceptual model that links ownership structure, R&D and firm innovative performance. Agency and stewardship theory carefully predict the behavior of managers and a firm in general based on the owner’s identity and the concentration of ownership (blockholder ownership). When blockholder ownership increases, agency problems decrease because commitment of owners will be higher and monitoring of managers will improve. In addition, when blockholder ownership is high, the owners are less able to diversify their risks and R&D expenditures will be lower.

Furthermore, inside owners, as opposed to outside owners, have better access to internal information and therefore have an advantage regarding monitoring of managers (when they are not owners) and accompanying expenditures. Overall, the relationship between managers and inside owners appears to be closer than the relationship between managers and outside owners. In addition, both inside owners and managers have a tendency to underinvest in R&D, they are less able to diversify their risks or there is an emotional involvement.

Moreover, the findings of this study indicate that blockholder ownership has a negative relationship with R&D expenditures in Europe, whereas insider ownership has a negative relationship with R&D expenditures in Continental Europe only. In addition, it is found that in Continental Europe and Europe, both blockholder ownership and outsider ownership negatively interact with the positive relationship between R&D and firm innovative performance.

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1. INTRODUCTION

The focus of this research is on the relationship between (1) ownership structure,

(2) R&D investments (input measure of innovation) and (3) firm innovative performance (output measure of innovation) in Europe. In current literature, these terms are part of an ambiguous web of descriptions and relations.

1.1 Justification

“The single strongest predictor of investment value is degree of innovativeness of the company.” - Cooper (1990: 44)

“The Wall Street consensus is that redistribution, not innovation, should be driving the stock market.” - Lazonick (2007: 1029)

As the two quotes of Cooper (1990) and Lazonick (2007) imply, owners (investors) can have a significant influence on the actual innovativeness of firms. Most often, investors look at their own portfolios and the firm they consider investing in, but other owners and their relationship with the firm’s management are possibly even more important as they influence the firm’s strategic goals and accompanying investment decisions. Therefore, it is essential to gain insight into how the identity of owners or the concentration of ownership (i.e. fewer owners results in higher concentration) influence a firm’s R&D investment decisions and the resulting innovative performance. The practical side is that analysts could use this information to estimate a firm’s future (innovative) performance.

The influence of ownership structure on firm performance in Europe has been studied widely in various settings as part of corporate governance research (Delgado-García, De Quevedo-Puente & De la Fuente-Sabaté, 2010; Perrini, Rossi & Rovetta, 2008; Thomsen & Pedersen, 2000). However, regarding the relationship between ownership structure and either R&D (input) or firm innovative performance (output), most research is conducted in Anglo-Saxon countries, especially the US (Barca & Becht, 2002; Baysinger, Kosnik & Turk, 1991; Lazonick, 2007), where firms are widely held and agency conflict between unmonitored managers and widely dispersed shareholders emerge (Perrini et al., 2008). Also more collectivistic countries such as Japan and South Korea are subject to a great deal of interest (Choi, Park & Hong, 2012; Lee & O’Neill, 2003), where ownership is generally concentrated among strategically oriented stable shareholders (Hu & Izumida, 2008), the opposite of the fragmented ownership by investors in the Anglo-Saxon countries. Moreover, the research setting is often related to the nationality of author’s institutions (McNulty, Zattoni & Douglas, 2013). Furthermore, Munari, Oriani & Sobrero (2010) confirm the findings above and state that studies on the impact of ownership structure on innovation activities have been mainly based on US data, with mixed results.

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aﬃrmations based on empirical work in the US institutional context might lead to counterproductive results”. Therefore, they state that corporate governance issues might diﬀer in character and extent for other regional areas. However, this does not necessarily mean that insights from one geographical area cannot be useful for another. Building on the foundations laid by Anglo-Saxon context studies, only just recently corporate governance research considering either R&D or firm innovative performance in Europe has started to gain some considerable interest, considering the publication dates of important papers to be used in this research: Brossard, Lavigne & Sakinç (2013); Munari et al. (2010); Perrini et al., 2008. Therefore, in line with this development, this research will also contribute to this European setting. The focus will be on Europe, specifically Western Europe (including Scandinavia) and Southern Europe.

Furthermore, the relationship between ownership and either R&D or firm innovative performance appears to lack a solid theoretical fundament in Continental Europe. To date, research on ownership and R&D has provided mixed results, and the majority is restricted to an Anglo-American context (Hoskisson, Hitt, Johnson & Grossman, 2002; Tribo, Berrone & Surroca, 2007; Tylecote & Ramirez, 2006). In fact, very little is known regarding how ownership influences R&D expenditures in Continental Europe (Tribo et al., 2007), and the same accounts for the relationship between ownership and firm innovative performance (Munari et al., 2010).

Several theoretical perspectives are used in corporate governance, R&D, and innovation literature that can provide constructive contributions to this research: agency theory (e.g. Hoskisson et al., 2002), resource dependence theory (e.g. Adegbesan & Higgins, 2010), stewardship theory (e.g. Lee & O’Neill, 2003), and also institutional theory (e.g. Coriat & Weinstein, 2002; O’Sullivan, 2000). Agency and stewardship theory will make the most important contributions, they will enable a clear discussion of ownership structure and firm innovative performance and at the same time discussing these perspectives will contribute to the knowledge of the perspectives themselves.

1.2 Ownership structure

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only focus on financial consequences of ownership structures. Jensen & Meckling (1976) discuss how firm value and wealth are eﬀected by managers’ expenditures and its market value and Demsetz & Lehn (1985) consider the market value of a given fraction of ownership (value-maximizing size), costs of managerial control, and the (financial) eﬀects systematic regulation (i.e. increasing or reducing control for owners).

An essential dimension of ownership structures that can be perceived by stakeholders is the ownership concentration in the hands of the largest shareholder (Delgado-García et al., 2010), also defined as the ‘blockholder’. It is measured as the fraction owned by largest or most significant shareholders (Sánchez-Ballesta & García-Meca, 2007). Besides ownership concentration, a second dimension can be perceived: insider ownership. As the term implies, it is usually measured as the proportion of shares held by insiders (Sánchez-Ballesta & García-Meca, 2007): a special form of insider ownership is managerial ownership, where day-to-day decision-makers also have ownership rights. Also a third dimension can be perceived, the identity of owners (Thomsen & Pedersen, 2000). Identity of owners allows for a thorough identification of diﬀerent insiders and, also of great importance, outsiders. According to Thomsen & Pedersen (2000), ownership concentration measures the amount of influence (power) shareholders have on managers, while the identity of the owners (e.g. state, family, institutional) has implications for their objectives and the way they exercise their power, which is reflected in company strategy with regard to profit goals, dividends, capital structure and growth rates and innovation.

1.3 R&D and firm innovative performance

In addition to the focus on corporate governance in Europe, this study will extend current research on the relationship between ownership structure and R&D investments (input measure), as conducted by Munari et al. (2010), as well as current research on ownership structure and productivity of investments (output measure, inventions, patents), as conducted by Choi et al., (2012). This will be based on a clear distinction between input and output measures of innovation. To the best of my knowledge, currently no research exists that considers the relationship between ownership structure and both R&D expenditures and firm innovative performance. In this research setting, productivity of investments can also be seen as the extent of firm innovative performance whereby R&D can be seen as the means to achieve it. However, it should be stated that the focus will not be on the extent of innovativeness of inventions. I will assume that inventions do not necessarily have to be useful (Van de Ven, 1986) and the focus will therefore be restricted to the creation of the actual invention since it is very hard to make a value judgment regarding usefulness of inventions and corresponding patents, subsequent commercialization is therefore not of interest in this study.

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2. LITERATURE REVIEW

In this section I will provide an in-depth discussion of the concepts ownership structure, R&D and firm innovative performance. Firstly, I will thoroughly discuss the concept ownership structure, including the most relevant accompanying theoretical concepts. Secondly, I will discuss the role of R&D (input) and firm innovative performance (output) in corporate governance. In the next section I will formulate hypotheses regarding how the concepts relate to each other. Due to the complexity of the relationships, it is best to already reveal the proposed conceptual model: see figure 1.

Figure 1: Conceptual model (hypotheses excluded)

2.1 Corporate governance and ownership structure

An important factor of corporate governance is the alignment of interests of shareholders with the interests of managers. However, the concern is whether managers pursue their own interests or maximize shareholder value: shareholders delegate decision-making to managers and control to a supervisory board (Lehmann & Weigand, 2000), therefore there is an agency relationship (Jensen & Meckling, 1976). The interests of management in general do not, and need not, naturally coincide completely with those of owners. Therefore it would appear that corporate resources are not used entirely for the creation of shareholder profit (Demsetz & Lehn, 1985). In addition, firms with a controlling minority structure, where a controlling shareholder exercises control but owns only a small fraction, are common around the world (Joh, 2003). Joh (2003) states that in firms with a controlling minority structure, the controlling shareholder’s benefit from appropriating firm resources exceeds its cost. Therefore, controlling shareholders have an incentive to pursue their private benefits at the expense of other shareholders, often described as expropriation. The less a controlling shareholder owns, the higher the incentive to pursue private benefits (Jensen & Meckling, 1976).

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guarantee that they will take actions that do not disadvantage the principal, and the third is loss incurred by any divergence between agents’ decisions and decisions that would maximize the principal’s wealth (Jensen & Meckling, 1976).

However, Davis, Schoorman & Donaldson (1997) propose stewardship theory as an extension of agency theory. They argue that agency theory is an ‘economic approach to governance’, which sees subordinates as individualistic, opportunistic, and self-serving. Stewardship theory is a more ‘social’ approach and sees subordinates as collectivists, pro-organizational, and trustworthy. Therefore, agency theory represents misalignments of motives and objectives between principals and ‘stewards’, while stewardship theory represents a situation of alignment and agreement (Davis et al., 1997). When a ‘steward’ attains the objectives of the organization (e.g. sales growth), set by the owners or principals, this will eventually benefit principals such as outside owners through positive eﬀects on dividends and share prices and by doing so, this will also benefit the ‘steward’ (Davis et al., 1997). In their study of ownership structures and R&D investments of US and Japanese firms, Lee & O’Neill (2003) propose that agency theory is more appropriate for a US context with high individualism, dispersed ownership - no single owner owns more than 20% of the company's shares (Pedersen & Thomsen, 1997) - and clear separation of ownership and control, while the stewardship theory is possibly more relevant for a Japanese context where ownership concentration is high, relationship-based, and collectivism is an essential element of the culture.

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Country Amount of companies Largest voting block: median 2nd largest voting block: median 3rd largest voting block: median Austria 50 52.0 2.5 0* Belgium 140 56.0 6.3 4.7 Germany 372 57.0 0* 0* Spain 193 34.5 8.9 1.8 France CAC40** 20.0 5.9 3.4 Italy 214 54.5 5.0 2.7 The Netherlands 137 43.5 7.7 0* Sweden 304 34.9 8.7 4.8 UK 207 9.9 6.6 5.2 USA NYSE 1309 5.4 0* 0* NASDAQ 2831 8.6 0* 0*

Table 1: Size of voting blocks (Barca & Becht, 2002)

*Voting block either not exists or below +5% disclosure level **Main stock price index (CAC 40)

2.1.1 Identity of owners

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represent other investors and hold diversified portfolios because country-specific laws worldwide require them to do so. In contrast to the reasoning of David et al. (2001), in this research I will consider banks as inside owners (Brossard et al., 2013; Lehmann & Weigand, 2000). More arguments in favor of this assumption will be discussed in section 2.1.3. In addition, two additional types of owners, board members (Sánchez-Ballesta & García-Meca, 2007) and managers (e.g. controlling minority structure (Joh, 2003)), are also often seen as important inside owners.

Furthermore, Thomsen & Pedersen (2000) argue that owner-managed companies, compared to investor-owned companies, are less likely to undertake ambitious investments to exploit economies of scale and more likely go for market niches. They argue that institutional investor ownership has therefore advantages for a firm regarding finance, aversion of low risk and a long time horizon, while family ownership often means that families (or certain individuals representing the family) have a double role as owners and managers. For example, Anderson, Duru & Reeb (2012) have found that family-owned firms will allocate relatively less capital to long-term investments than firms with a dispersed ownership structure.

Bushee (1998) finds that a higher percentage of institutional ownership in a certain firm decreases the likelihood that the firm’s managers reduce R&D expenditures to meet (personal) short-term earnings goals. Due to the nature of institutional investors (e.g. long-term focus (Brossard et al., 2013), institutional investors are willing to take the substantial costs of explicitly monitoring managers. In family owned firms, however, any important investments that are made, will be focused on physical assets (i.e. human capital), which may create long-term commitment to the survival of the company (Anderson et al., 2012). However, this also makes them risk-averse and family members could misuse their position to derive private benefits at the expense of other - minority - shareholders (Thomsen & Pedersen, 2000), previously referred to as expropriation.

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2.1.2 Blockholder ownership

Blockholder ownership, the fraction owned by largest or most significant shareholders does not imply a specific ownership ratio, however there appears to be consensus in the literature. David, Hitt & Gimeno (2001), Lee & O’Neill (2003), and most other authors in the field (Sánchez-Ballesta & García-Meca, 2007), measure and refer to it as the percentage of ownership by large block shareholders (or just ‘large shareholders’) with greater than 5% ownership. Most authors discussing blockholder ownership look at its’ relationship with firm value. As firm value is a reflection of a firm’s (innovative) performance (Delgado-García et al., 2010), the discussions on firm value can act as a representation of the possible relationship between blockholder ownership, R&D and firm innovative performance.

Hu & Izumida (2008) state that the relationship between ownership and firm performance cannot only be considered as a one-way, causal relationship: it is possibly endogenous, whereby also a feedback-effect exists and firm performance influences ownership structure. They state that if blockholders are concerned about their returns on the stocks, they may increase their ownership of firms that perform well and benefit from possibly future growth and persistence of current performance, while they will possibly decrease ownership in firms that are confronted with high risks, decreased performance and serious opportunity costs. Of course, in both cases the decision is also influenced by the share prices. In addition, Sánchez-Ballesta & García-Meca (2007) argue that ownership concentration is expected to positively affect firm value directly because large shareholders have the incentive to increase profits by actively monitoring managers (agents) and repress any misalignment of goals between principals and agents, however, they note that a high concentration of ownership may become ineffective for taking value-maximizing decisions, and may therefore be counteracting. So, while concentrated ownership can limit the agency problem (Jensen & Meckling, 1976), above certain levels of ownership concentration, stakeholders may perceive that controlling blockholders can also expropriate minority shareholders and other stakeholders (Delgado-García et al., 2010). The relationship between ownership concentration and firm performance or firm value, is therefore found to be nonlinear.

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Barca & Becht (2002) have considered what kind of blockholders have the largest voting blocks in diﬀerent European countries and find that institutional investors are the largest holders of voting blocks in the UK (although the blocks are small), whereas in Continental Europe, families and companies (i.e. not financial institutions) own the largest voting blocks. In some countries, such as the Netherlands, also banks appear to be important blockholders. Lehmann & Weigand (2000) state that in Germany, individuals or families are often large blockholders which are the founders or inheritors of the company, which causes considerable emotional involvement and personal attachment. Therefore, according to Lehmann & Weigand (2000), insider ownership does not necessarily enhance performance.

2.1.3 Insider ownership

The research field of corporate governance sees differing entities as insiders, depending on which authors discuss the subject. For example, Choi et al. (2012) see corporate founders, their families, affiliates, managers, and employees as inside owners, while Lehmann & Weigand (2000) state that corporations having individuals or families, banks, or different independent large shareholders may be interpreted as potentially governed by committed insiders. Especially the inclusion of banks is interesting, but not surprising since banks will often act as a credit provider. They also argue that for firms owned by another industrial firm it might be managers rather than the ultimate owners who control the managers of the owned company, these firms are mostly subsidiaries of large quoted stock corporations. The interests of management in general do not, and need not, naturally coincide completely with those of owners, therefore it would appear that corporate resources are not used entirely for the creation of shareholder profit (Demsetz & Lehn, 1985). For example, managers might execute a diversification strategy with a short-term focus on maximizing profits and empire (i.e. reputation) building (Thomsen & Pedersen, 2000). Or they could even take higher risks because they do not feel responsible for possible extra incurred costs, also known as moral hazard or opportunism (Lazonick, 2007).

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2.2 Innovation, R&D and innovative performance

“Innovation might be one of a few lasting sources of competitive advantage.” - Crossan & Apaydin (2010: 1174)

“Innovation is a prerequisite of sustained growth. No other path to profitable growth can be sustained over time. Without continual innovation, markets stagnate, products become commodities, and margins shrink.” - Cooper (2011: 14).

When trying to measure innovative performance, there are two categories of measurement possibilities available (Munari et al., 2010): (1) input measures of a firm’s innovation activities, and (2) output measures of innovation activities. The most important input measures are R&D investments and R&D intensity, which have the disadvantage that the productivity of the investments is hard to measure (Choi et al., 2012; Munari et al., 2010). However, the productivity of investments can be determined by using output measures, which implies counting: (registered) patents or citation-weighted patents, new product introductions, or corporate entrepreneurship (Choi et al., 2012; Munari et al., 2010). However, Choi et al. (2012: 281) encountered the disadvantage of this measurement themselves: “not all firms protect their technological assets and innovations with patents, some may prefer trade secrets”. In addition, obtaining a patent is expensive and it can take years to get the necessary approval (Von Hippel & Von Krogh, 2006). Teece (1986) even states that patents hardly provide perfect appropriability and protection (except for chemical products), at relatively low costs others can invent around a certain patent since the content it covers has been disclosed. However, patents, which represent (technical) innovations, can present a relatively unbiased (Ahuja & Lampert, 2001) picture of the association between ownership structure and innovative performance.

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In addition, when managers do see the advantage of innovation for their firm and act accordingly (i.e. make significant investments in R&D), again the vision of owners might diﬀer since considerable R&D investments also mean a decrease in firm value (at least on paper), lower dividends and a lower amount of possible stock repurchases (O’Sullivan, 2000; Lazonick, 2007).

Tribo et al. (2007) discuss a couple of concepts regarding R&D expenditures that are highly relevant to this research. Firstly, they state that to date research on the relationship between ownership concentration (i.e. blockholder ownership) and a firm’s R&D expenses has provided mixed results: some have found a positive relationship, while others found a negative or neutral relationship. Secondly, they state that most studies have examined this relationship in Anglo-American contexts (e.g. Hoskisson et al., 2002; Tylecote & Ramirez, 2006), however also some research regarding Japanese firms has been conducted (e.g. Lee & O’Neill, 2003). Lastly, they state that very little is known about the relationship between ownership concentration and a firm’s R&D expenses in Continental Europe. However, Tribo et al. (2007) and Munari et al. (2010) have shown interest in this relationship. The studies of Tribo et al. (2007) and Munari et al. (2010) consider the relationship between blockholders and R&D investments in Spanish firms, and R&D investments and owner identity in Western European firms, respectively. Tribo et al. (2007) state that banks are conservative organizations and the money invested is seen as ‘debt’ by both bank and the - partly - owned firm. Therefore, in order to reduce the burden, the firm will tend to invest in short-term projects.

Furthermore, Tribo et al. (2007) argue that R&D investments are mainly long-term oriented and therefore they find that find that the impact of large shareholders on the R&D investment is negative when blockholders are banks. Secondly, they find that the impact of large shareholders on the R&D investment is positive when blockholders are non-financial corporations. They reason that that non-financial owners have no ‘credit relationships’ with the firms they control and are more likely to see the need for R&D investments. Furthermore, they state that sometimes the controlled firms are used as an instrument to outsource the incumbent (owner) firm’s R&D activities. Thirdly, they find that non-institutional blockholders have neither a positive nor a negative impact on R&D investments. Munari et al. (2010) find no support for their reasoning that the share of ownership controlled by families or states positively aﬀect a firms’ R&D investments. However, they do find that there is a negative relationship between the share of ownership controlled by families and R&D investments. In addition, they find that widely held firms in the UK will exhibit lower R&D investments than widely held firms (dispersed ownership with no single controlling owner) in Continental European countries.

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technological innovation performance of firms, and insider ownership and technological innovation performance. However, they do find support for the presumed positive, direct relationships between ownership by institutional investors and technological innovation performance, and foreign ownership and technological innovation performance.

Moreover, Choi et al. (2012) have certain expectations regarding governmental ownership and ownership by institutional investors, based on the resource dependence theory. This theory states that survival of organizations depends on the ability to acquire critical resources (e.g. financial) from the external environment (Adegbesan & Higgins, 2010). Choi et al. (2012) argue that governments and institutions are often resource-rich outsiders who can act as boundary-spanners to bring in the necessary - financial - resources for R&D, this partly coincides with the conclusions of David et al. (2001) who state that prior research has found a positive relationship between institutional ownership and R&D inputs.

2.3 Summary literature review

To conclude, the literature review appears to indicate that agency and stewardship theory carefully predict the behavior of managers and the firm in general based on the owner’s identity, which makes it either an outsider or insider to the firm, and the ownership concentration: higher blockholder ownership means higher ownership concentration (less dispersed). When blockholder ownership increases, agency problems decrease because commitment of owners will be higher and therefore also the monitoring of managers will improve. In addition, when blockholder ownership is high, the owners are less able to diversify their risks and R&D expenditures will be lower. Furthermore, inside owners, as opposed to outside owners, have better access to internal information and therefore have an advantage regarding monitoring of managers (when they are not owners) and accompanying expenditures.

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3. HYPOTHESES

In this section, I will formulate hypotheses based on the discussed literature.

3.1 R&D expenditures and blockholder ownership

Agency theory and its extension, stewardship theory, play an important role within corporate governance literature (Davis et al., 1997; Jensen & Meckling, 1976). While agency theory is more appropriate for countries with high individualism and dispersed ownership (Lee & O’Neill, 2003), stewardship theory applies more to countries where ownership concentration (blockholder ownership) is high, relationship-based, and collectivism is an essential element of the culture (Pedersen & Thomsen, 1997). The relationship between agent and principals regarding R&D expenses, although very important, does not appear to be very diﬀerent in Continental Europe than in, for example, the US or UK. However, in countries where ownership is on average dispersed, agency theory proposes that, due to the relatively small investments, risk can be diversified using investment portfolios (Munari et al., 2010) and therefore investors (owners) are willing to take some risks regarding R&D investments. Since ownership concentration in Continental Europe is in general very high (Barca & Becht, 2002), it would appear that in Continental Europe R&D investments (and its output, innovation) are made with more caution. In addition, stewardship theory would imply that the managers will act in the interest of the owners (i.e. dutiful, assiduous) regarding R&D expenditures. Therefore, regarding blockholders and R&D expenditures in Continental Europe, where ownership concentration is “staggeringly high” (Barca & Becht, 2002: 2), I propose the following hypothesis:

H1: Blockholder ownership (large shares of ownership by a small amount of investors) has a negative relationship with R&D expenditures

However, Hill & Snell (1989) find that ownership concentration is positively related to R&D expenditures per employee. Based on this fully US-based empirical analysis it therefore appears that in contrast to Continental Europe, in the UK the relationship between blockholder ownership and R&D expenditures might be positive.

3.2 R&D expenditures and identity of owners

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2012; Munari et al., 2010; Thomsen & Pedersen, 2000). Anderson et al. (2012) and Munari et al. (2010) found a negative relationship between family ownership and R&D investments. Regarding non-institutional investors, the discussion of Lehmann & Weigand (2000) covers the concept of management being in control of another firm. In this case, corporate resources might be used up to a certain extent for the interests of management instead of actual owners (Demsetz & Lehn, 1985).

This is a pure form of agency conflict since R&D investments are mainly long-term oriented (Tribo et al., 2007) while managers try to establish their own positions by going after short-term gains (Thomsen & Pedersen, 2000). In contrast to the reasoning above concerning insider ownership, outsider ownership as institutional ownership has a proven, albeit merely based on US context, positive relationship with R&D expenditures (Bushee 1998; David et al. 2001). As opposed to banks, families and non-institutional investors (industrial corporations), institutional investors display more of what O’Sullivan (2000) and Lazonick & O’Sullivan (2000) define as “financial commitment”. In addition, inside owners have the largest voting blocks in Continental Europe (i.e. most insiders are also blockholders), whereas in the UK (Anglo-Saxon countries in general) the largest voting blocks are in the possession of outside owners (Barca & Becht, 2002).

Therefore, regarding insider ownership, conclusions regarding the defined hypothesis above might also apply for inside owners in Europe, specifically Continental Europe. Therefore, I propose the following hypothesis regarding the relationship between insider ownership and R&D investments:

H2a: Insider ownership (i.e. banks, families, non-institutional - corporate - ownership) has a negative relationship with R&D expenditures

As will be discussed, my sample contains ownership data of the five largest owners (C5). This implies that total ownership per firm does not always add up to 100 percent. Therefore, a separate hypothesis for outside owners is a necessity:

H2b: Outsider ownership (i.e. institutional investors) has a positive relationship with R&D expenditures

3.3 From R&D to actual innovative performance

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technological innovation performance of firms, overall their empirical analysis indicates that there is neither a positive nor a negative relationship between ownership concentration and technological innovation performance. This would imply that blockholder ownership would not either increase or decrease the actual innovative performance of a firm. Regarding this particular relationship I suggest that, as can be seen in the conceptual model, there is no direct relationship between ownership structure and firm innovative performance since R&D (input) needs to be conducted to be able to generate innovative outcomes (output). Therefore, considering the proposed hypothesis in section 3.1 (H1), I expect that while blockholder ownership reduces R&D expenditures, it will not have any negative influence on the actual innovative outcomes of the firm.

On average, the amount of patents per R&D dollar will increase with the concentration of ownership because of efficiency improvements. This is partially confirmed by findings of Hill & Snell (1989), who find that concentration of ownership increases actual productivity of firms, and Perrini et al. (2008) who find that ownership concentration leads to stronger firm performance. Firm innovative performance might therefore also be stronger. In contrast, Huang, Lai, McNamara & Wang (2011) find that blockholder ownership negatively affects firm efficiency in terms of cost efficiency and technical efficiency in the US insurance industry. This could imply that also the efficiency of R&D is decreased.

Taking the above in consideration, it appears that academic literature is in favor of a positive effect of blockholder ownership on firm performance. Even the findings of Choi et al. (2012) appear to hint at efficiency improvements since a decrease in R&D expenditures and no influence on innovation performance implies an efficiency improvement. Therefore, I propose the following hypotheses regarding the relationship between blockholder ownership and firm innovative performance in Europe:

H3a: Blockholder ownership positively moderates the relationship between R&D and firm innovative performance

H3b: Blockholder ownership has a positive relationship with R&D eﬃciency (patents/R&D)

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Regarding the identity of owners, to the best of my knowledge, there is not enough research conducted to develop well-considered theories. However, the hypothesized decrease (H2a) of R&D expenditures by inside owners appears to be in favor of a more creative approach to R&D. While outsiders (H2b) are expected to increase R&D investments, there is no immediate need for the firm to be more economical in terms of assignment of R&D dollars to certain projects and its evaluations. Therefore, I propose the following hypotheses knowing that outsider ownership is an opposing force compared to insider ownership (H2a and H2b):

H4a: Insider ownership positively moderates the relationship between R&D and firm innovative performance

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4. METHODOLOGY

A quantitative approach will be taken to determine the eﬀect of ownership structure on R&D expenditures (input) and firm innovative performance (output). My empirical analysis is partially based on the work of Choi et al. (2012), Munari et al. (2010) and Perrini et al., 2008. Due to the triangular shape of the conceptual model, some variables will be used as both dependent and independent or independent and moderating based on which particular relationship is measured.

4.1 Sample and data collection

The necessary data for my empirical analysis has been extracted from the Bureau van Dijk Orbis database, which contains information about the financial performance, R&D expenditures, patents, shareholders, amount of employees, and more of over 103 million active companies around the world. Within this database I have applied the following search strategy:

- companies owned by at least one shareholder

- companies owned in Western Europe (including Scandinavia and Southern Europe) - types: banks and financial companies, insurance companies, industrial companies,

private equity firms, hedge funds, venture capital, public authorities, states, governments, one or more named individuals or families, publicly listed companies - ownership of individual owners between 5,00% to 100,00%

- R&D expenses of 2006, 2007, 2008, 2009 and 2010

- the results above have been cross-referenced with the Orbis patent database: patents filed between 1 January 2008 and 31 December 2012

This search strategy provided me with a sample of 1.241 companies. Important information on corporate governance has been provided by Barca & Becht (2002). Furthermore, much consistent data is available concerning how Western Europe is situated with respect to corporate governance, culture and legislation compared to Anglo-Saxon and Asian countries (e.g. Davis et al., 1997). The 5 percent owner threshold (i.e. at least one blockholder owner for every firm in the sample) is based on Perrini et al. (2008) and is done to only have companies in the sample with at least one owner with a a certain (minimum) amount of control. The Orbis database has provided me with fifteen diﬀerent shareholder types (see table 2), which have been sorted based on the identity of each owner (ownership categories), as defined by Thomsen & Pedersen (2000).

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Lastly, regarding the C5 measure (5 largest owners of each company) all firms with more than 102% ownership have been omitted: these were firms where the ownership percentages of diﬀerent shareholders were just rough estimates or where old and new ownership data have been mixed. The ownership percentages of a small number of firms with total ownership between 100% and 102% (within C5) have been adjusted. The final Continental European sample contains 462 firms, divided over Western Europe as follows: 8 Austrian, 19 Belgian, 36 Swiss, 108 German, 15 Danish, 14 Spanish, 42 Finnish, 54 French, 2 Icelandic, 19 Italian, 1 Luxembourgian, 15 Dutch, 12 Norwegian, 1 Portuguese and 116 are Swedish.

Orbis shareholder types Classification 1/0

Industrial company Insider 1

Mutual & Pension Fund/Nominee/Trust/Trustee Outsider 0

Public authority, State, Government Insider 1

Foundation/Research Institute Insider 1

Financial company Outsider 0

Bank Insider 1

Insurance company Outsider 0

Public (publicly listed companies) Outsider 0

One or more named individuals or families Insider 1

Private Equity firms Outsider 0

Self ownership Insider 1

Venture capital Outsider 0

Other unnamed shareholders, aggregated* Outsider 0

Employees/Managers/Directors Insider 1

Unnamed private shareholders, aggregated Outsider 0

Table 2: shareholder classification based on Thomsen & Pedersen (2000) *Most often they appear to be outsiders

4.2 Measures

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Dependent Independent Moderator H1 H2a H2b H3a H3b H4a H4b AVG_RnD Total_blockholders AVG_RnD C5_insider AVG_RnD C5_outsider

Patented_time AVG_RnD Total_blockholders Patents_RnD Total_blockholders

Patented_time AVG_RnD C5_insider Patents_RnD C5_insider

Table 3: hypotheses and classification of variables

As can be seen in table 3, in every hypothesis one of the following three variables is used: (1) the ratio of either insider or outsider ownership of the up to five largest shareholders (C5_insider and C5_outsider, respectively), and (2) the total amount of blockholder shareholders (Total_blockholders) with ownership of more than five percent.

The data of C5 (five largest owners) appears to be more reliable than any data beyond C5 (e.g. 8th largest owner). The more owners we consider, the more below the disclosure level (Barca & Becht, 2002) we will get, which is why only ownership information of up to five largest owners regarding insider/outsider ownership is used. Accordingly, in the sample, the sum of C5_insider and C5_outsider is the total ownership within C5 and therefore does not always add up to 100 percent. However, considering the disclosure level, ownership data of blockholders should in general be reliable, no matter how many blockholder owners there are, although there is a theoretical maximum of twenty owners. Furthermore, as discussed, the sample has been selected in such a way that for every firm in the sample, there is at least one blockholder owner. Therefore, every firm has at least one owner with a reasonable amount of control.

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Despite the advantages of patent citations (Hall, Jaﬀe & Trajtenberg, 2005), the chosen timeframe to represent a contemporary look on corporate governance (recent literature) and innovation in Continental Europe is not in favor of the use of patent citations because not enough time has past. This also coincides with the view of Crossan & Apaydin (2010) regarding the citation-based method and newly published papers, which poses the same problems as newly published patents.

To make sure the proposed conceptual model, related arguments and conclusions are robust, I will use various control variables in this research: (1) the firm’s country of origin (Country, converted to integers), (2) number of employees in 2012 (Employees), and (3) operating revenue in 2012 (Revenue). In addition, to increase robustness, I have calculated two extra variables, (4) C5_ratio and (5) C5_blockholder_ratio:

C5_ratio = (C5_insider) / (C5_insider + C5_outsider)

This measures the ratio of outsiders/insiders, close to 1 means a larger share of ownership by insiders (total ownership within C5 always > 0 within the dataset). Since ownership within C5 does not always add up to 100%, I divide by the

total ownership within C5.

C5_blockholder_ratio = (amount of blockholders within C5) / (total amount of investors within C5)

The total amount of investors varies between 1 (in case the first owner/investor has full ownership) and 5, therefore also in for this ratio division by zero is excluded.

4.3 Analysis

Descriptive statistics and bivariate analyses for the complete sample of 580 European firms, and its constituent parts, the UK (118 firms, Anglo-Saxon, common law) and Continental Europe (462 firms, civil law, high ownership concentration) are presented in Appendices A, B1, B2, and B3. The separate UK and Continental Europe analyses allow me to discuss their diﬀerences and add robustness to the model. Furthermore, the separate Continental European results help build up - necessary - knowledge regarding non Anglo-Saxon countries.

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Furthermore, the multicollinearity between Employees and Revenue made it impractical to keep both in the analysis. The findings of Hill & Snell (1989) regarding H1 make Employees the most interesting variable. In addition, C5_blockholder_ratio will also be used as an independent variable for the regression analyses since C5_blockholder_ratio is a diﬀerent measure of ownership concentration than Total_blockholders. For the calculation of C5_blockholder_ratio, I have used the total amount of blockholders within C5 (five largest owners), not the total amount of blockholders overall.

Therefore, considering the hypotheses, the following regression equations are most important:

H1 AVG_RnD_logi = β0 + β1 (Total_blockholders) + Ƶ + 𝓔i

H2a AVG_RnD_logi = β0 + β1 (C5_insider) + Ƶ + 𝓔i H2b AVG_RnD_logi = β0 + β1 (C5_outsider) + Ƶ + 𝓔i

H3a Patented_time_logi = β0 + β1(Total_blockholders) + β2(AVG_RnD_log) + β3(Total_blockholders x AVG_RnD_log) + Ƶ + 𝓔i H3b Patents_RnDi = β0 + β1 (Total_blockholders) + Ƶ + 𝓔i

H4a Patented_time_logi = β0 + β1(C5_insider) + β2(AVG_RnD_log) + β3(C5_insider x AVG_RnD_log) + Ƶ + 𝓔i H4b Patents_RnDi = β0 + β1 (C5_insider) + Ƶ + 𝓔i

where Ƶ = relevant control variables

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5. RESULTS

In this section, I will first start with discussion on the outcomes of the descriptive statistics. These will be compared to the findings of Barca & Becht (2002). Secondly, I will discuss the outcomes of the correlation and regression analyses regarding the hypothesized relationships. Appendix C2 presents a separate regression analysis with the significant results of C5_blockholder_ratio as independent variable. Thirdly, I will consider additional, non-hypothesized, results of the analyses. Lastly, the results will be summarized.

5.1 Descriptive statistics Continental Europe, the UK, and Europe

The descriptive statistics in Appendix A are in support of the findings of Barca & Becht (2002) regarding ownership concentration and ownership by insiders and outsiders in Continental Europe and Anglo-Saxon countries. Insider ownership (C5_insider) in Continental Europe is on average higher (mean = 55,14) than in the UK (mean = 33,02), whereas outsider ownership (C5_outsider) is lower in Continental Europe (mean = 19,44) than in the UK (mean = 26,88). In addition, in Continental Europe the total amount of blockholders (Total_blockholders) in a firm is lower (mean = 3,18) than in the UK (mean = 6,66), whereas the share of blockholder ownership (C5_blockholder_ratio) is higher in the UK (mean = 0,9271) than in Continental Europe (mean = 0,7616). This appears to indicate that for only half the amount of blockholders in Continental Europe, the share of ownership by blockholders is just 17% lower. In other words: ownership in the UK is more dispersed than in Continental Europe. As would be expected from these findings, the European descriptive statistics (both UK and Continental Europe included) are somewhere in between the values mentioned above.

5.2 Hypothesized relationships

H1: Blockholder ownership (large shares of ownership by a small amount of investors) has a negative relationship with R&D expenditures

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that obscures the bivariate correlations. In addition, as Appendices B1 (-0,125; p < 0,01) and B3 (-0,154; p < 0,01) show a negative correlation between the share of blockholder ownership and Employees, the conclusion of Hill & Snell (1989) that ownership concentration is positively related to R&D expenditures per employee is therefore not such a sharp contrast to H1 as previously claimed. However, because the correlation analyses show no significant correlations between the total amount of blockholders and R&D expenditures, no clear evidence is found.

H2a: Insider ownership (i.e. banks, families, non-institutional - corporate - ownership) has a negative relationship with R&D expenditures

H2b: Outsider ownership (i.e. institutional investors) has a positive relationship with R&D expenditures

Appendices B1, B2 and B3 reveal no significant correlations regarding insider and outsider ownership (C5_outsider) with average R&D expenses. However, Appendix C1 shows that only for Continental Europe, there is a significant, negative regression coeﬃcient (-0,066; p < 0,10) between insider ownership (C5_insider) and average R&D expenses. Therefore, only for Continental Europe, H2a can be confirmed. Regarding the UK (Anglo-Saxon countries) and Europe, H2a is rejected. Due to the lack of significant results, H2b can be rejected overall.

H3a: Blockholder ownership positively moderates the relationship between R&D and firm innovative performance

H3b: Blockholder ownership has a positive relationship with R&D eﬃciency (patents/R&D)

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H4a: Insider ownership positively moderates the relationship between R&D and firm innovative performance

H4b: Insider ownership has a positive relationship with R&D eﬃciency (patents/R&D)

Appendix C1 shows no significant results for the proposed interaction eﬀect of insider ownership on the relationship between R&D and firm innovative performance, H4a is therefore rejected. Furthermore, there are also no significant results for H4b, which is therefore also rejected.

5.3 Non-hypothesized results

In section 5.2, it became clear that the findings indicate that blockholder ownership negatively moderates the relationship between R&D and firm innovative performance in Continental Europe and Europe, instead of the hypothesized positive interaction effect. Besides this, the analyses also covered non-hypothesized relationships which resulted in two interesting outcomes. Firstly, Appendix C2 reveals that the share of blockholder ownership (C5_blockholder_ratio) has a positive correlation (0,430; p < 0,05) efficient with the amount of patents published (Patented_time, firm innovative performance) in Europe, when R&D and the interaction effect are included. However, this is only the case when both blockholder ownership and R&D are considered (i.e. multicollinearity). Secondly, Appendix C1 reveals that outsider ownership (C5_outsider) is a negative moderator of the (positive) relationship between R&D and patents (firm innovative performance) in Continental Europe (-0,505; p < 0,05) and Europe (-0,304, p < 0,10). In addition, although not very surprising, Appendices C1 and C2 clearly show that R&D expenses have a positive effect on firm innovative performance (patents). 5.4 Summary of results Relationships Independent Dependent Dependent Interaction R&D expenditures Innovative

performance (patents) R&D Patents Blockholder

ownership Insider ownership Outsider ownership

Negative* Positive* Negative***

Negative**

Negative*** Table 4: summary of results hypothesized relationships

***Continental Europe & Europe **Continental Europe

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6. DISCUSSION AND CONCLUSION

In section 6.1, I will discuss the results and come to conclusions regarding the diﬀerent regional areas (Continental Europe, the UK, Europe) considered in this research. In section 6.2 I will discuss the managerial implications of the outcomes, followed by a discussion on the research implications and possibilities for future research in section 6.3.

6.1 Research question and theoretical implications

In this study, I have covered the relationship between ownership structure, R&D and firm innovative performance in Europe. It provides interesting, but mixed results (see table 4). Firstly, it appears that in the UK, representing Anglo-Saxon countries, ownership structure has no significant relationship with either R&D expenditures or firm innovative performance. Or, regarding R&D, probably a better reflection of the reality is as follows: the relationship between ownership structure and R&D expenditures is ‘neutral’. Regarding ownership concentration, this has been found more often (Tribo et al., 2007). This implies that neither agency theory nor stewardship theory is relevant for the UK, managers act on their own behalf. But agency theory does provide me with what this means for R&D investments. Because owners are not able to diversify their risk through a portfolio of investments, they will probably choose the ‘safer‘ path of exploitation instead of exploration. For ownership identity (insider/outsider), comparison with other research is somewhat more complex as each paper tends to develop its own identity classification. However, my choice to assign diﬀerent identities to either insider ownership or outsider ownership might have been a bit too strict (i.e. too black and white). In addition, I suggest conducting the same analyses again using panel data, this would benefit the rigidity of the overall results and could reveal data inconsistencies of the current dataset.

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Thirdly, in Europe, blockholder ownership (ownership concentration) makes up for interesting results. In Europe, blockholder ownership has a negative effect on R&D expenditures, but at the same time positively influences firm innovative performance and negatively interacts with the positive relationship between R&D and firm innovative perforance, see table 4. As in Europe, most blockholders are insiders, also in this case the goals of the majority of owners and managers are aligned (stewardship theory) since diversifying risks is difficult (agency theory). Furthermore, just as in Continental Europe, the effectiveness of R&D will be lower due to the negative interaction of blockholder ownership. However, the remarkable result here is that blockholders have a positive effect on firm innovative performance (patents). As patents are mostly the result of explorative research (in order to successfully apply for a patent, the invention should be clearly new), it appears that in Europe there is strong reliance on legal instruments (Teece, 1986) for appropriating value from innovations. In addition, also in Europe outsider ownership negatively interacts with the positive relationship between R&D and patents. This could imply that outside interference with R&D activities, makes R&D less effective. Therefore, agency theory perfectly fits this situation and implies that both in Continental Europe and Europe overall, R&D will be less efficient due to the difference in goals among managers and insider owners on the one hand, and outsider owners on the other.

6.2 Managerial implications

As a spare time investor, I am personally interested in companies that will perform well in the long-term. Unfortunately, it appears that current investors, especially institutional investors, merely look at R&D expenditures, financial performance (e.g. revenue) and product portfolio. This research shows the importance of the identity of - other - owners regarding R&D expenditure decisions and eventual innovative performance. A firm may be able to perform well under current circumstances, but should be able to perform at least equally as good, if not better, tomorrow. As the former Executive Vice President of Intel Corporation, Leslie L. Vadasz, described it: “there is absolutely no reason why an organization that you created two years ago has any relevance to the organization that you need two years from now” (Schoonhoven & Jelinek, 1990: 240). Especially non-blockholders should realize that the identity and intensity of large shareholders aﬀect the investment strategies of a firm.

6.3 Research limitations and future research

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Furthermore, I noticed that one invention does not necessarily lead to one patent. I found some cases wherein firms had filed for multiple patents in different regional areas, covering the same invention. In addition, the choice to measure patents as a representation of firm innovativeness implies that the sample consists of relatively large firms. In my case, the average amount of employees within the sample (Europe) is 14.452 employees. These are firms that are able to afford patents in general, including any potential legal disputes over interferences. Moreover, according to Conway & Steward (2009: 225): “patents provide only weak protection, are easy to 'invent around’, or have transitory value given the pace of technological change”, which coincides with the reasoning of Teece (1986). Therefore, also firms that can afford patents and should be able to apply for one, could still decide to use secrecy as a way to protect innovations.

Moreover, the existence of shareholder privacy mechanisms such as bearer shares in a large amount of European countries (e.g. Austria, Belgium, Denmark, France, Germany, Luxembourg, the Netherlands, Portugal, Spain) could have made data collection hard. Even for European countries that issue registered shares (e.g. Finland, Italy, Sweden, the UK), there could have been problems with obtaining ownership data since companies are not obliged to publish them (Barca & Becht, 2002). However, due to EU regulations, in many European countries voting blocks of more than 5% should be published (Barca & Becht, 2001; Siems & Schouten, 2009). In contrast to my expectations, it appeared that in practice, enough data on actual ownership (also below the threshold) is available. R&D data and patent information, however, were more diﬃcult to collect and this therefore required me to take a wide perspective in this research. The actual plan was to conduct this research on corporate governance, R&D and firm innovative performance in the energy industry. However, data availability was very limited and direction was changed.

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7. APPENDICES

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Appendix B1 - correlation analysis Continental Europe

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Appendix B2 - correlation analysis UK

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Appendix B3 - correlation analysis Europe

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Appendix C1 - regression analyses

Note: Standardized regression coeﬃcients are reported

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Appendix C2 - regression analysis (C5_blockholder_ratio)

Note: Standardized regression coeﬃcients are reported

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