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Many investors and governance experts believe that “skin in the game” of managers, i.e. substantial stock and option ownership of top management, is good for firm value. Managers who own a lot of stock have aligned incentives with shareholders and will work hard to maximize shareholder value. However, if management has too much ownership, it may take decisions that are detrimental to minority shareholders and good for themselves.

The academic world has provided evidence consistent with these beliefs. An important and well-documented result in corporate finance research is that firm value is positively correlated with managerial ownership over some range of ownership and then, beyond that range, becomes negatively correlated. Several theory papers model the tension between managerial ownership and incentives and predict such a concave relation: It is good when managers have some skin in the game, but if they own too many shares, they become entrenched.

A limitation of this evidence is that it uses databases that include few small firms and few young firms.  In our paper, we build a database that is much richer than any database used in the literature. With this database, we find that for many firms, managerial ownership by managers is high simply because the firm’s stock has not been liquid enough for managers to sell shares. These firms have both high managerial ownership and low value. Our evidence shows that when considering the implications of managerial ownership, it is important to take into account that there are costs of reducing managerial ownership for managers and that these costs may lead a firm to have high managerial ownership for reasons other than the firm wanting managers to have skin in the game.

We build a new database of managerial ownership information by parsing original SEC documents. While the samples in existing studies are tilted towards large firms and have data for few years, we have much broader coverage from 1988 to 2015 as we have data for more than 1,800 publicly listed US firms per year on average. We show using our large database that the relationship between firm value and ownership is more complicated than previously thought. With our sample, we find strong and robust evidence that the relation between firm value and managerial ownership is negative rather than positive and thus opposite to theoretical predictions and prior empirical findings. Yet, when we restrict our sample to the subset of larger firms similar to the samples used by earlier work, we recover their findings of a positive relationship between value and managerial ownership over some range of ownership.

We show that the consistently negative relation between firm value and managerial ownership uncovered in our sample has a straightforward explanation. Insiders own more shares at the IPO than they typically want to own over time. As a result, they want to decrease their ownership, but face frictions in doing so. If a firm’s stock is illiquid, it takes time and it is expensive to sell large stakes. Managers may not even be able to sell under conditions that are acceptable to them. The level of managerial ownership of a firm therefore depends on its past history. If the firm’s stock is highly liquid quickly after the IPO, managers decrease their ownership, and the firm eventually has low managerial ownership. The firms whose stock is liquid are typically successful firms, which means firms with a high Tobin’s q. Hence high q firms tend to have low managerial ownership. Conversely, firms with high managerial ownership are firms whose stock has lacked liquidity. Such firms are firms that have not been consistently successful, and therefore end up with high managerial ownership and low q.

Our explanation for the negative relation between managerial ownership and Tobin’s q is that higher liquidity decreases managerial ownership and that some of the forces that lead to higher liquidity increase Tobin’s q as well. In particular, better operating performance generally improves both liquidity and Tobin’s q. We find strong support for the hypothesis that a stock is more liquid if its cumulative past performance is better. We then show that Tobin’s q is also higher for firms with greater past performance.

Overall, our evidence suggests that theories of firm value and managerial ownership should take into account frictions that impede adjustments in managerial ownership.

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