Journal Of Network Theory In Finance

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Directors’ networks and firm valuation in a concentrated ownership structure economy

Ronen Barak and Oren Kapah

  • The effect of the director's importance (centrality) in the network is very dependent on the type of director.
  • Central non-external (and presumably) expert directors tend to promote firm valuation and mitigate the negative impact of a pyramidal control structure.
  • Central-External (independent) directors have a tendency to harm firm performance and even magnify the negative effect of the vote-ownership wedge.
  • The results give credence to the claim that when the legal environment allows it, shareholders with controlling interests, act as shadow directors through their formidable influence on external directors in order to consume private benefits of control. 

ABSTRACT

We explore the implications of directors' networks for company valuation in a concentrated ownership environment and in pyramidal control structures. Using common centrality indexes on a sample of 727 directors serving in 105 Israeli listed firms, we show that the effect is very dependent on the type of director. Directors who are neither external nor ultimate owners, and therefore presumably experts, tend to promote firm valuation and mitigate the negative impact of a pyramidal control structure. Conversely, central external directors have a tendency to harm firm performance and even magnify the negative effect of the vote-ownership wedge, due to the pyramidal ownership structure. Our findings support the claim that shareholders with controlling interests are, in fact, shadow directors, who utilize their excessive influence on external directors to carry out tunneling (ie, the diversion of value from the company for their own personal gain).

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