Foreign ownership, leverage and firm performance: an analysis of the European football industry.

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Master Thesis

Foreign ownership, leverage and firm performance: an

analysis of the European football industry.

By Florian Jambor

University of Groningen Faculty of Economics and Business MSc International Business & Management

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The purpose of this study is to examine how foreign ownership affects the financial performance of football clubs. In particular, this study distinguishes between the direct and indirect implications of foreign ownership on performance by reconciling the research findings of the international business and corporate governance literatures. This study employs the generalized method of moments estimation using data from a sample of 42 clubs from the five major European football leagues during the period 2012-2017. Contrary to the extant foreign ownership-performance literature, it was found that foreign ownership has a negative impact on performance and a positive impact on financial leverage. Financial leverage has a negative impact on performance. The results reveal that foreign ownership cannot function as a monitoring mechanism in the corporate governance of European football clubs, because it is too concentrated.

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4 1. Introduction

The relationship between foreign ownership and firm performance has marked the finance and international business literatures for decades. Foreign ownership has been associated with a positive impact on firm performance as a result of ownership advantages such as technological know-how, superior management and marketing capabilities, or easier access to financial and human resources, that accrue to foreign owners (Caves, 2006; Douma et al., 2006). From the agency theory perspective, there is the contention that foreign owned firms are generally better monitored and controlled and, thus, present an overall more robust financial performance (Jensen and Meckling, 1976; Thomsen and Pedersen, 2000). Despite the fact that the vast majority of scholars seem to agree that foreign owned firms generally tend to outperform their domestic counterparts (Boardman et al., 1997; Douma et al., 2006; Khanna and Palepu, 1999; Koo and Maeng, 2006; Nakano and Nguyen, 2012), there are also studies that reveal a non-linear relationship between foreign ownership and firm performance, suggesting that up to a certain level, increases in foreign ownership enhance performance, however, when the level of foreign ownership becomes too high, the relationship turns negative (Gurbuz and Aybars, 2010; Azzam et al., 2013; Greenway et al., 2012; Choi et al., 2012).

Research to date within the foreign ownership-performance literature has concentrated on the implications of foreign ownership on profitability. Indeed, there appears to be limited research on the relationship between foreign ownership and its impact on financial leverage (Bamiatzi et al., 2017). Given that high leverage has long been identified as an indicator of firm failure (Beaver, 1966; Graham and Rogers, 2002; Leland, 1998) and is associated with a higher probability of default (Molina, 2005), the impact of foreign ownership on the degree of leverage, could add an essential piece to the foreign ownership-performance puzzle. In order to fully appreciate the role of foreign ownership on performance, it is necessary to look beyond profitability-related measures. Therefore, this paper aims to not only look at the direct, but also at the indirect implications of foreign ownership on performance.

This empirical study examines whether foreign owned firms have ownership-specific advantages that allow them to enhance performance relative to their domestic counterparts. The central research question of this study is as followed: Does foreign ownership enhance

performance? In line with the vast majority of the foreign ownership-performance literature,

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5 following two sub-questions: (1) does foreign ownership have a direct impact on performance? and (2) does foreign ownership have an indirect impact on performance through its impact on

firm leverage? This study focuses on football clubs from the European football industry.

The motivation for choosing the European football industry is twofold. First, the increasing presence and perceived domination of European football clubs owned by foreign investors, initiated a debate on their controversial financial impact. On the one hand, foreign owners are held responsible for the overinvestment environment that has been characterizing the football industry in recent years. On the other hand, takeover deals have been connected with substantial debt reductions. Nevertheless, the empirical evidence on the impact of foreign ownership remains scarce. The second reason is of theoretical concern, because the football industry has characteristics that distinguishes it from more conventional industries, i.e., manufacturing or services. As a result of the increasing commercialization, the football industry is characterized by low information asymmetry (Andreff, 2007). Furthermore, bankruptcy costs for football clubs are significantly lower than for firms from other industries, because dedicated stakeholders such as fans and communities are likely to step in when clubs are in financial distress. The fact that financial mismanagement has such low costs is the source of the agency problem in modern football clubs (Storm, 2012).

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6 This study makes several contributions. It contributes to the international business and corporate governance literature since it examines the impact of foreign ownership on firm performance and capital structure decisions and reconciles the research findings from these two literature strands, respectively. This study is also a contribution to both the agency theory as well as the concept of “ownership advantages” since the underlying relationships are examined within these theoretical frameworks. Finally, by focusing on the European football, this study investigates an industry with growing interests and corporate value, but with little empirical evidence.

The rest of the paper is structured in the following way. In the second chapter, the competing views and empirical evidence on the relationship between foreign ownership and performance are reviewed. Since this study also examines the relationship between foreign ownership and financing decisions, the next section provides brief insights into the foreign ownership-capital structure literature. The second chapter closes with the research gap and the hypotheses development. The third chapter presents an overview of the methodology, including the research sample, the key variables, the estimation technique and a data analysis. The fourth chapter presents the empirical results. Finally, the fifth chapter concludes with a discussion on the limitations and weakness of this study and provides suggestions for future research.

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2. Literature Review

2.1. Foreign versus domestic ownership and performance

A large number of scholars from different strands of the literature have attempted to identify the impact of foreign ownership on performance. Despite the ample amount of studies, findings remain inconclusive, with empirical studies confirming both positive and negative relationships.

Foreign ownership has been associated with positive performance, as a result of ownership-specific advantages that accrue to foreign owners. Among others, Caves (1996) and Douma et al., (2006) have identified technological know-how, superior management and marketing capabilities, and easier access to financial and human resources, as potential advantages. If firms are able to successfully import these advantages to a foreign market, they can exploit host market imperfections and easier overcome transaction costs, the liability of foreignness and other barriers of internalization (Barbosa and Louri, 2005; Dunning, 1998; Harris and Robinson, 2003; Markides and Ittner, 1994). With regard to the empirical literature, there exists an ample amount of evidence that confirms foreign superiority over domestic counterparts (Boardman et al., 1997; Caves, 1996; Douma et al., 2006; Huang and Shiu, 2009; Khanna and Palepu, 1999; Koo and Maeng, 2006; Ongore, 2011; Wellalage and Locke, 2012).

The relationship between foreign ownership and corporate performance is less clear-cut from an agency theory perspective, with empirical studies depicting both positive and negative relationships. On the one hand, foreign corporate ownership is said to promote shareholder protection by strengthening managerial control. This is particularly true when firms are operating in less market-oriented institutional contexts that are characterized by institutional voids. Here, foreign ownership can help to bridge the institutional voids (Heugens et al., 2009). Since foreign owners generally exhibit higher concentration of share ownership, they are better able to “set and effectively impose control mechanisms that maximize performance” (Jensen and Meckling, 1976), ultimately leading to foreign superiority over domestic counterparts (Thomsen and Pederson, 2000). On the other hand, higher concentration of share ownership may lead to minority shareholder expropriation and thus have adverse effects on performance.

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8 beyond the point of inflection, the costs associated with higher control outweigh the benefits. Choi et al., (2012) examine the impact of foreign ownership and firm performance for a sample of Korean listed firms over the period 2004 to 2007 and confirm an inverted U-shaped relationship. They argue that initial increases in foreign ownership promote stronger corporate governance, but if the level of foreign ownership becomes too high, then the board of directors loses its independence and firm performance declines.

2.2. Foreign ownership and capital structure

A key task of the corporate governance literature has been to resolve the ambiguity around the nature of the relationship between the level of debt in firms’ capital structure and economic performance (Williamson, 1988). Modigliani and Miller (1958) proposed that under certain assumptions, the composition of firms’ capital structure, defined by the ratio of debt to equity, is irrelevant from an economic point of view. A number of scholars have argued that in more realistic theoretical settings, the level of debt actually has an impact on firms’ performance (Jensen and Meckling, 1976; Myers and Majluf, 1984). Among others, the general characteristics of firms’ ownership structure have been identified to determine the level of debt in firms’ capital structure and there is good reason to believe that there may be interrelations between the structures of ownership and capital. The empirical literature on the relationship between ownership structure and capital structure has mostly focused on family, managerial, insider, or institutional ownership (Bajaj et al., 1998; Berger et al., 1997; Bokpin and Arko, 2009; Chu, 2011). Only a few studies have examined the influence of foreign ownership on capital structure (Le and Tannous, 2016; Li et al., 2009; Huang et al., 2011; Zou and Xia, 2006; Gurunly and Gursoy; 2010;). The results remain inconclusive, identifying positive, negative, and no relationship at all.

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9 that foreign ownership may serve as a substitute for debt in controlling the opportunistic behavior of managers.

There is only a limited number of studies that hypothesize a positive influence of foreign ownership on capital structure. Zou and Xiao (2006) believe that foreign owners have an information disadvantage relative to their domestic counterparts. Additionally, foreign owners generally tend to diversify their portfolios and, thus, have a lower percentage of shareholding in each firm where they invest. As a result, foreign owners have relatively low monitoring power over management. Given that up to a certain point, debt may function as a monitoring mechanism by restricting the availability of free cash flows to managers, foreign owners may encourage firms to issue more debt. Another argument for a positive influence of foreign ownership on capital structure is offered by Gurunlu and Gursoy (2010) who argue that foreign owners increase a firm’s capacity to access external funds on more favorable conditions and, thus, lower the cost of debt.

2.3. The impact of debt on performance

This section examines the role of debt on performance and risk by delving into the capital structure-performance literature, which dates back to the seminal works of Modigliani and Miller (1958; 1963). Modigliani and Miller (1958) developed the capital-structure levance proposition which argues that in perfect capital markets (no taxes, no transaction costs, no bankruptcy costs, and no information asymmetry), the market value of a firm is independent of the way it chooses to finance its investments or distribute dividends. Given the over-restrictive assumptions that the capital-structure irrelevance proposition builds on, Modigliani and Miller (1963) introduced the tradeoff theory of leverage, which includes both the effects of taxes and bankruptcy costs. This theory recognizes that optimal capital structure is the result of a tradeoff between benefits and costs associated with debt (Modigliani and Miller, 1963).

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10 leverage, additional debt may actually increase agency costs to compensate debt holders for being exposed to higher financial risk (Berger and Di Patti, 2006).

Myers (2001) shows that high leverage constrains firms to become involved in valuable investment opportunities, that is, a firm which pursues its shareholders’ interests and is characterized by high leverage will tend to follow a different investment decision rule than one that is characterized by low – or no leverage at all. This is because a highly-leveraged firm is required to compensate its debt holders for facing higher financial risk and, thus, evaluates investment opportunities using higher discount rates and lower net present values, compared to a firm with lower levels of leverage. Therefore, high leverage can lead to suboptimal investment policies and induce a firm to forgo valuable investment opportunities that could have made positive net contributions to their market values (Jensen and Meckling, 1976).

Furthermore, firms with relatively high leverage may be more inclined to engage in risker investment projects with higher expected profits, regardless of the costs to their overall credit and default risk (Wiseman and Catanach, 1997). Indeed, Long and Malitz (1985) show that moral hazard problem, which influence a firm’s investment decisions, is a major determinant of corporate leverage. Molina (2005) attempts to resolve the ambiguity around the capital structure puzzle of why firms do not use more leverage, by using the firm’s debt rating as a proxy for the default risk. He finds that an increase in leverage translates into a lower market rating and ultimately into a higher probability of default. In situations of financial distress, the impact of leverage on default is magnified and carries the consequence that highly leveraged firms tend to be relatively more inefficient, which can show up in a performance decline. Opler and Titman (1994) provide evidence that in situations of financial distress, highly leveraged firms tend to experience more significant losses in market share, lower levels of stock returns and higher sensitivity of stock prices changes that.

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11 2.4. The peculiar economics of professional football clubs

The motivation for investigating the direct and indirect implications of foreign ownership on performance within the context of the European football industry is of theoretical concern. The injection of funds from wealthy foreign individuals into the European football industry leads to the separation of ownership and control and, ultimately, gives rise to the agency conflict (Berle and Means, 1932). However, the agency conflict is more severe for football clubs due to industry specific characteristics, such as the absence of bankruptcy costs (Gerrard, 2007). This is because several stakeholders such as fans or local communities will step in and help to bail out when their clubs are in financial distress. Indeed, Kennedy (2012) points out that football clubs have a remarkable survival rate, given that the majority of them operate on the edge of bankruptcy. Therefore, football clubs do not fit into the classical framework of firm financial distress and debt cannot function as a monitoring mechanism. The low costs of financial mismanagement are the source of the agency problem and can explain why European football clubs have accumulated significant amounts of debt over the past decade (Bosca et al., 2008; Lago et al., 2006).

Storm and Nielsen (2012) apply the concept of soft budget-constraint to the European football industry in order to enhance the understanding of the peculiar economics of professional football clubs. They argue that the paradox that football clubs operate on the brink of bankruptcy and still keep high survival rates, can be explained by the fact that modern football clubs suffer from the soft budget-constraint syndrome. The soft budget-constraint syndrome, a concept formulated by Kornai (1979), is likely to appear “whenever a funding source finds it impossible to keep a firm to a fixed budget, i.e., whenever the firm can extract ex post a bigger subsidy or loan than would have been considered efficient ex ante” (Maskin, 1994). More specifically, the soft budget-constraint syndrome refers to the decisions maker’s behavior, in particular, his expectations about the future financial situation of the firm that stands in a principle-agent relationship to the funding source (Kornai, 1986). If the decision maker expects the funding source to step in and bail out the firm in case of financial distress, then he is inclined to increase expenditure above the initial budget, leaving the additional costs for the principal to pay. This situation appears to describe modern football clubs very accurately. In their theoretical work, Storm and Nielsen (2012) show that as a result of the soft budget-constraint syndrome, football clubs which are owned by wealthy private majority investors, tend to accumulate relatively higher levels of debt.

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12 2.5. Research gap and questions

As noted in the introduction and presented in the above section, the majority of empirical studies has focused on the direct implications of foreign ownership on performance. In particular, most of these studies have tried to demonstrate that foreign owned firms exploit ownership-specific advantages that help them to overcome the barriers of internalization and enhance performance relative to their domestic counterparts. Performance has mostly been measured using profitability-related variables. It seems that only a limited number of studies has examined the foreign ownership-performance relationship on wider performance measures. For example, Kronborg and Thomson (2009) find evidence that as a result of ownership advantages that are transferred from parent firms, foreign subsidiaries have significantly lower exit risk compared to their domestic counterparts. Fatemi (1984) argues that foreign ownership has a positive impact on performance by reducing financial risk, yet does not provide any explanations about its impact on debt.

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13 2.6. Hypotheses development

Significant differences can exist in the performance of foreign and domestic owned firms. It is widely agreed that foreign ownership positively affects firm performance, because foreign owners are in the possession of tangible and intangible resources such as technological know-how, superior management and marketing capacities, and easier access to financial and human resources, which allow their firms to gain a competitive advantage over the domestic counterparts (Caves, 2006; Douma et al., 2006). According to agency theory, foreign owned firms are generally better monitored and controlled and, thus, present an overall more robust financial performance (Jensen and Meckling; 1976). There is an ample amount of studies that confirm a positive influence of foreign ownership on firm performance (Boardman et al., 1997; Chhibber and Majumdar, 1999; Douma et al., 2006; Khanna and Palepu, 1999; Koo and Maeng, 2006; Nakano and Nguyen, 2002).

In the context of sports organizations, it would also be expected that foreign owned clubs outperform their domestic counterparts. Nevertheless, the empirical evidence within this field remains scarce and has mostly focused on the role of private majority investors and not distinguished between domestic and foreign owners (Frank, 2010b; Lang et al., 2001). Given the increasing presence of foreign owners in European club football, it is surprising that no empirical study has focused on examining their financial impact. Football clubs with higher foreign ownership presumably have ownership advantages such as superior access to financial resources. Ultimately, the superior access to financial resources should enable foreign owned clubs to increase their spending power relative to their domestic counterparts. This in turn, should allow them to attract greater human resources, i.e., playing talent and managerial capital, which should translate into higher sporting success and revenue generation. Ceteris paribus, these competencies should translate into superior performance vis-à-vis firms with lower or negligible foreign holdings. This leads to the first hypothesis:

H1: Foreign ownership positively affects performance.

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14 foreign ownership on performance. The European football industry provides a unique business setting for examining the impact of foreign ownership on performance and financing decisions. The absence of bankruptcy costs and the fact that football clubs do not fit into the classical framework of firm financial distress, implies that debt cannot play its disciplinary role in restricting managerial entrenchment (Gerrard, 2007). Consequently, the agency problem is expected to be more severe in the football industry than in other business sectors.

It would be expected that the agency problem is more severe for football clubs with higher foreign ownership. Foreign owners increase a firm’s capacity to access external funds on more favorable conditions and thus lower a firm’s cost of debt (Gurunlu and Gursoy, 2010). Given that debt cannot play its disciplinary role in restricting managerial entrenchment, it would be expected that football managers exploit the low cost of debt and engage in empire building to promote sporting success. Storm and Nielsen (2012) apply the concept of soft-budget constraints to the European football industry, to explain why football clubs, which are owned by wealthy private majority investors, tend to accumulate substantial amounts of debt. “Managers who are expecting bailouts or support in case of financial trouble ex post, have strong incentives to increase expenditure above the initial budget, leaving the additional costs for the principal to pay, thus resulting in a softening of their budget constraints.” This situation seems to explain the source of the agency problem of foreign owned football clubs very accurately. Consequently, it would be expected that football clubs with higher foreign ownership are characterized by higher leverage. This leads to the second hypothesis:

H2: Foreign Ownership positively affects club leverage.

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15 increase agency costs in foreign owned football clubs. Nevertheless, football clubs that use more debt relative to equity in their capital structure are characterized by higher financial distress and thus constrained to engage in valuable investment opportunities, i.e., the signing of new playing talent. Consequently, it may be expected that high leverage is a burden and negatively affects performance. This leads to the third hypothesis:

H3: Higher leverage negatively affects club performance.

3. Data and Methodology

3.1 Data and Sample

The hypotheses are tested on a research sample that consists of an unbalanced panel of football clubs from the five main European leagues: the English Premier League, Ligue 1 of France, the German Bundesliga, the Italian Serie A, and the Spanish La Liga, over the period 2012 to 2017. The full sample includes 252 firm-year observations (42 clubs, 6 years). The reason why the sample is restricted to these five leagues is because of limited data availability. Only for these five leagues, the financial data is available for all clubs in the league, that is, for the other European leagues only data for the largest clubs of the league can be obtained. Nevertheless, it appears that the sample is representative, because from all 24 leagues of the “European Leagues Association” the top five leagues combined, generated 58.65 percent of total revenues in the season 2016/2017 (Deloitte, 2018). Given that these leagues generate significantly higher revenues and attract greater publicity, they have also attracted significantly more funds from wealthy foreign investors. Looking at the ownership data confirms that these five leagues exhibit by far the most significant within-variation of foreign – and domestic ownership. Finally, the reason why the sample is restricted to the period 2012 to 2017 is also due to limited data availability. For most clubs in the sample the financial data is only available since the year 2012.

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16 and The Global Sports Salaries Surveys 2012-2017 and are measured in current USD ($). Information regarding the controlling rights of foreign owners were compiled from the clubs’ annual reports and home pages.

3.2. Measures

Table 1 provides an overview of the variables used in the analysis. The key variables in this analysis are club performance, club leverage, and foreign ownership. Club performance will be evaluated on the basis of the widely adopted profitability ratio, return on equity (ROE), which is defined as net income over the book value of equity. ROE indicates how efficiently management is utilizing shareholder’s equity to generate income. The ROE ratio is among the most frequently used financial ratios to evaluate the overall effectiveness of firm management (Kangarlouei, 2012). Club leverage (LEV) is measured by a club’s debt to total assets ratio. Finally, this analysis will take a similar approach as the extant foreign ownership literature (Douma et al., 2006; Li et al., 2009; Le and Tannous, 2016) and measure foreign ownership in terms of the percentage of ownership controlled by foreign investors. Previous literature has identified the following control variables to be crucial determinants of performance and leverage.

Club size, which will be operationalized through the natural logarithm of each club’s

total assets, is said to have significant impact on performance. According to the literature, larger firms are better able to exploit economies of scale and scope and have the capacity to exert greater control over external stakeholders and resources (Orlitzky, 2001). On the contrary, smaller firms tend to be more adaptive to changes in the competitive environment (Douma et al., 2006). From the perspective of professional football clubs, it would be expected that larger clubs can attract greater players and managers, which in turn, promote sporting success and lead to higher revenue generation. Therefore, a positive relationship between club size and performance is to be expected. Club size could also have a significant impact on leverage. Bevan and Danbolt (2000) point out that the relationship between firm size and debt depends among others on the type of debt, firm-specific characteristics and even the type of methodology employed. Nevertheless, the general contention is that firm size is positively correlated with leverage, because larger firms have a lower probability of default and thus easier access to debt, respectively (Rajan and Zingales, 1995).

Age is another important determinant of firm performance that has been identified by

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17 adapt to changes in the competitive environment (Douma et al., 2012). From the perspective of professional football clubs, it would be expected that clubs which have been established for a longer period of time have managed to build a larger fan-base and are also more experienced in dealing with the competitive pressures of the industry. Therefore, a positive relationship between club age and performance is to be expected.

Player salaries, which will be measured by the natural logarithm of the average annual

player salary of a given football club, is another control variable for performance. Player salaries can be used as an adequate proxy for sporting success. Clubs that pay higher salaries presumably have attracted greater playing talent, are better able to promote sporting success and, ultimately, tend to generate higher revenues. Therefore, a positive relationship between player salaries and performance is to be expected.

Asset tangibility, which most commonly has been defined by the literature as the ratio

of total fixed assets to total assets, serves as a proxy for the availability of collateral and will help to control of leverage. However, following the argument of Benkraiem et al. (2010) that modern football clubs heavily base their operations on intangible assets like player contracts or brand names, this study will measure asset tangibility as the ratio of intangible assets to total assets. Over the last decade a large number of football clubs have invested beyond their capacities and relied heavily on debt financing to acquire greater playing talent. Therefore, asset tangibility is expected to be positively correlated with leverage (Titmand and Wessels, 1988; Rajan and Zingales, 1995).

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18 3.3. Estimation Technique

In order to examine the direct and indirect impact of foreign ownership on performance, the following panel regression models will be run:

𝑅𝑂𝐸𝑖𝑡 = 𝛼0+ 𝛼1𝐹𝑂𝑅𝑖𝑡+ 𝛽𝑋𝑖𝑡+ 𝛾𝑌𝑒𝑎𝑟 𝐷𝑢𝑚𝑚𝑖𝑒𝑠 + 𝛿𝐶𝑙𝑢𝑏 𝑑𝑢𝑚𝑚𝑖𝑒𝑠 + 𝜀𝑖𝑡 (1) 𝐿𝐸𝑉𝑖𝑡 = 𝛼0+ 𝛼1𝐹𝑂𝑅𝑖𝑡+ 𝛽𝑋𝑖𝑡+ 𝛾𝑌𝑒𝑎𝑟 𝐷𝑢𝑚𝑚𝑖𝑒𝑠 + 𝛿𝐶𝑙𝑢𝑏 𝑑𝑢𝑚𝑚𝑖𝑒𝑠 + 𝜀𝑖𝑡 (2) 𝑅𝑂𝐸𝑖𝑡 = 𝛼0+ 𝛼1𝐿𝐸𝑉𝑖𝑡+ 𝛽𝑋𝑖𝑡+ 𝛾𝑌𝑒𝑎𝑟 𝐷𝑢𝑚𝑚𝑖𝑒𝑠 + 𝛿𝐶𝑙𝑢𝑏 𝑑𝑢𝑚𝑚𝑖𝑒𝑠 + 𝜀𝑖𝑡 (3) where 𝑅𝑂𝐸_𝑖𝑡 is return on equity of club i at time t, 𝐿𝐸𝑉_𝑖𝑡 is the ratio of debt to total assets of club i at time t, 𝐹𝑂𝑅𝑖𝑡 is the percentage of foreign shareholdings of club i at time t, 𝑋𝑖𝑡𝑠 are the control variables of club i at time t, and 𝜀_𝑖𝑡 is the error term.

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19 The generalized method of moments (GMM) method deals with the above mentioned concerns of dynamic panel data analysis and will be used to test the hypotheses. After modifying the original model specification to include the lagged variables of performance and leverage, the new model specification is as follows:

𝑅𝑂𝐸𝑖𝑡 = 𝛼0+ 𝛼1𝑅𝑂𝐸𝑖,𝑡−1+ 𝛼2𝐹𝑂𝑅𝑖𝑡+ 𝛽𝑋𝑖𝑡+ 𝛾𝑌𝑒𝑎𝑟 𝐷𝑢𝑚𝑚𝑖𝑒𝑠 + 𝛿𝐶𝑙𝑢𝑏 𝑑𝑢𝑚𝑚𝑖𝑒𝑠 + 𝜀𝑖𝑡 (4) 𝐿𝐸𝑉𝑖𝑡 = 𝛼0+ 𝛼1𝐿𝐸𝑉𝑖,𝑡−1+ 𝛼2𝐹𝑂𝑅𝑖𝑡+ 𝛽𝑋𝑖𝑡+ 𝛾𝑌𝑒𝑎𝑟 𝐷𝑢𝑚𝑚𝑖𝑒𝑠 + 𝛿𝐶𝑙𝑢𝑏 𝑑𝑢𝑚𝑚𝑖𝑒𝑠 + 𝜀𝑖𝑡 (5)

𝑅𝑂𝐸𝑖𝑡 = 𝛼0+ 𝛼1𝑅𝑂𝐸𝑖,𝑡−1𝛼2𝐿𝐸𝑉𝑖𝑡+ 𝛽𝑋𝑖𝑡+ 𝛾𝑌𝑒𝑎𝑟 𝐷𝑢𝑚𝑚𝑖𝑒𝑠 + 𝛿𝐶𝑙𝑢𝑏 𝑑𝑢𝑚𝑚𝑖𝑒𝑠 + 𝜀𝑖𝑡 (6)

where 𝑅𝑂𝐸_𝑖𝑡 is return on equity of club i at time t, 𝑅𝑂𝐸_{𝑖,𝑡−1}is return on equity of club i at time

t-1, 𝐿𝐸𝑉_𝑖𝑡 is the ratio of debt to total assets of club i at time t, 𝐿𝐸𝑉_{𝑖,𝑡−1} is the ratio of debt to total assets of club i at time t-1, 𝐹𝑂𝑅𝑖𝑡 is the percentage of foreign shareholdings of club i at time t, 𝑋_𝑖𝑡𝑠 are the control variables of club i at time t, and 𝜀_𝑖𝑡 is the error term. The lagged versions of the dependent variables have been identified to be appropriate instruments for the GMM method (Dimitropoulus, 2014; John and Litov, 2010; Phung and Mishra, 2016).

One problem that has not been addressed yet concerns the potential bias that arises if the independent variables are correlated with the lagged dependent variables. This happens when the time invariant effect of the error term of the independent variables prevents the lagged dependent variable to become isolated from the composite error process. In order to overcome this problem, Anderson and Hsiao (1982) propose to take first differences of the model. The first difference transformation removes the time invariant effect of individuals and makes it possible to proceed with the instrumental variable estimation. The instruments may be constructed from the second and third lags of the dependent variable. Even though the instruments are correlated with the lagged dependent variable, they are uncorrelated with the composite error process (Roodman, 2009).

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4. Results

4.1. Descriptive statistics and correlations

The summary statistics for all variables in the model are displayed in Table 2. On average, football clubs in the sample achieve a ROE of 0.24, which supports the general contention that European football clubs are relatively unprofitable. A ROE below 1 implies that management is relatively ineffective in using shareholder’s equity to generate income. Nevertheless, the range between minimum ROE and maximum ROE is large. The highest ROE, 91.89, was achieved by the Spanish club Real Betis in the year 2012. On the other hand, the English Premier League club Aston Villa, which has 100 percent foreign shareholdings, reported the lowest ROE, -69.86, in the year 2015. With regard to leverage, the descriptive statistics show that, on average, the football clubs in the sample have a mean debt to total assets ratio close to 1. This implies that the average club in the sample owns the same amount of liabilities as its assets and indicates that the average club is highly leveraged. Furthermore, the average club in the sample has 47 percent of foreign shareholdings.

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21 Table 3 presents the Pearson correlation matrix computed for each pair of variables. In order to be able to isolate the economic relationship between foreign ownership and performance, it is necessary to ensure that the predictors do not exhibit multicollinearity. One possible example of multicollinearity in this study could be that foreign investors might choose to invest in larger clubs or older clubs with greater tradition. However, from the Pearson correlation matrix it can be seen that multicollinearity does not seem present a problem for this study. The correlation coefficient between foreign ownership and club size is 0.31. The correlation coefficient between foreign ownership and club age is 0.08. Given that correlation coefficients for each pair of variables are relatively small, it can be concluded that there does not appear to exist a systematic relationship between the predictors.

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22 4.2. Regression results

4.2.1. Foreign ownership and performance

The results from the GMM panel regression model (4) are presented in Table 4. Column (1) presents the baseline model with club size as the only control variable. Columns (2) and (3) present the extended model with two additional control variables, club age and the average annual player salary. All three models include club and year dummies to account for club and year effects. Contrary to H1, the results in column (1) and (2) of Table 4 show that foreign ownership negatively affects ROE. The coefficients are statistically significant at the 5 percent level. The average value of the coefficient for the foreign ownership variable is -0.15, which implies that a 1 percent increase in foreign ownership decreases the ROE ratio by around 0.15. Column (3) illustrates that when all three control variables are included, the relationship between foreign ownership and ROE becomes statistically insignificant. The coefficients of the control variables have the signs as expected, that is, club size, age, and the average annual player salary, all have a positive impact on performance. However, the high p-values indicate that the coefficients of the control variables are statistically insignificant. The Hansen test for over-identifying restrictions reveals no correlation between the instrument variables and the error term, implying that the employed instrument variables were economically meaningful.

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23 4.2.2. Foreign ownership and leverage

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24 4.2.3. Leverage and performance

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25

5. Conclusion

5.1. Discussion of the findings

The purpose of this study was to examine how foreign ownership affects the financial performance of football clubs. Research to date within the foreign ownership-performance literature has focused on the implications of foreign ownership on profitability. Indeed, there appears to be limited research on the relationship between foreign ownership and its impact on financial leverage (Bamiatzi et al., 2017). Given that high leverage has long been identified as an indicator of firm failure (Beaver, 1966; Graham and Rogers, 2002; Leland, 1998) and is associated with a higher probability of default (Molina, 2005), the impact of foreign ownership on the degree of financial leverage, could add an essential piece to the foreign ownership-performance puzzle. This study argued that in order to appreciate foreign ownership to the full, it is necessary to distinguish between its direct and its indirect implications for performance.

Contrary to the main hypothesis and the extant foreign ownership-performance literature (Boardman et al., 1997; Douma et al., 2006; Khanna and Palepu, 1999; Koo and Maeng, 2006; Nakano and Nguyen, 2012), this study finds a negative effect of foreign ownership on performance. One possible explanation for the findings relates to the inverted U-shaped relationship between foreign ownership and performance (Gurbuz and Aybars, 2010; Azzam et al., 2013; Greenway et al., 2012; Choi et al., 2012). Among the clubs that are characterized by some degree of foreign ownership, the average of foreign shareholdings is 73 percent. Greenway et al. (2012) finds that when foreign ownership increases to 47-61 percent, firm performance increases, but if foreign ownership increases beyond this threshold level, then performance starts to decline. Similarly, Choi et al. (2012) find empirical evidence for an inverted U-shaped relationship between foreign ownership and firm performance for a sample of listed Korean firms, arguing that initial increases in foreign ownership have a positive impact on performance by activating independent monitoring, but if the level of foreign ownership becomes high enough to control the board, then the relationship becomes negative. It appears that foreign ownership cannot serve as a monitoring mechanism in European football clubs and help to reduce agency costs by aligning the interests of managers and equity holders, because it is too concentrated. Within the highly concentrated ownership structures of foreign owned football clubs, the expropriation effect of minority shareholders appears to dominate the monitoring effect.

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26 hypothesized, this study finds evidence that foreign ownership positively affects financial leverage of European football clubs. Higher foreign ownership increases a club’s capacity to access external funds on more favorable conditions and thus lowers the cost of debt (Gurunly and Gursoy, 2000). Given that debt cannot play its disciplinary role in restricting managerial entrenchment, it would be expected that football managers exploit the low cost of debt and engage in empire building to promote sporting success. Furthermore, the agency problem seems to be amplified by the fact that foreign owned clubs suffer from the soft budget-constraint syndrome (Storm and Nielsen, 2012). In these clubs, the behavior of managers is guided by the expectations about the future financial situation of the club. Knowing that foreign owners will help to bail out the club in case of financial distress, managers can extract ex post a bigger loan that would have been considered efficient ex ante. This situation can explain why clubs which are owned by wealthy foreign investors, have accumulated significant amounts of debt over the last years and are characterized by relatively high financial leverage.

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27 5.2. Limitations and recommendations for future research

The greatest limitation of this study concerns the methodology. Due to limited time availability, I have not managed to perform any tests that assess the robustness of the above findings. In order to validate that the estimated coefficients for foreign ownership are plausible and robust, I recommend to employ alternative measures of firm performance. One problem with the use of ROE as a performance measure is that it is calculated after the cost of debt, but before taking into account the cost of own capital. This implies that ROE can increase with higher financial leverage. However, increases in financial leverage are accompanied by increases in financial risk, which may ultimately lead to shareholder value destruction. Indeed, Bhagat and Black (2001) point out that ROE is not neccessairly consistent with the creation of shareholder value. Therefore, I recommend to employ additional performance measures such as the return on assets, the ratio of earnings to sales, or the net profit margin.

Another limitation of this study concerns the second dependent variable, financial leverage. This study employed only one leverage ratio, namely, the ratio of debt to total assets. In order to assess the robustness of the results and to see whether the estimated coefficients have the correct signs, further leverage ratios could be employed. For example, it could be distinguished between short-term and long-term debt. This point is particularly relevant for the examination of the relationship between financial leverage and performance. Abor (2005) and de Mesquite and Lara (2003) find a positive relation between the ratio of short-term debt to total assets and performance, but a negative relation between the ratio of long-term debt to total assets and performance. In order to find clarity about the impact of foreign ownership on the debt levels of acquired firms, future studies could distinguish between different types of debt and also employ different measures of leverage.

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28 ownership on performance within the context of the football industry, could use the UEFA club coefficients as a proxy for sporting success.

Another suggestion for future research concerns the spillover effects of foreign investments within the domestic sector of a host country. Bloomstrom and Persson (1983) find evidence that foreign investments also raise the performance levels of domestic firms with no foreign ownership due to imitative effects. The sports industry provides an interesting setting for examining the spillover effects resulting from foreign investments, because it is highly competitive by nature. Dietl and Franck (2007) point out that a club’s individual chance to foster sporting success, does not depend on its absolute investment, but rather on the relative investment compared to all its rivals in the competition. Foreign ownership in football could lead to productivity and knowledge spillovers and therefore also have an impact on the performance of domestically owned clubs. To my knowledge the theory of FDI spillovers has not yet been applied to the football industry.

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29

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Foreign ownership, leverage and firm performance: an analysis of the European football industry.

Master Thesis