Insider ownership and corporate performance: Evidence from the adjustment cost approach

This paper examines the relation between insider ownership and corporate performance in the presence of adjustment costs and investigates how the adjustment costs are determined. In a model specification without adjustment costs, we find that insider ownership is significantly positively associated with corporate performance. But once we allow for adjustment costs, the relationship no longer exists. We find that insider ownership and corporate performance can be explained by their respective lagged values and that many firm characteristics that were previously useful in explaining these two variables turn out to be statistically insignificant. In addition, there is no evidence that insider ownership and corporate performance affect each other. This is consistent with the adjustment cost argument. It is also consistent with the "endogeneity" argument suggested by Demsetz [Demsetz, H. 1983. The structure of ownership and the theory of the firm. Journal of Law and Economics 26, 375-390.], Demsetz and Lehn [Demsetz, H., Lehn, K., 1985. The structure of corporate ownership: causes and consequences. Journal of Political Economy 93, 1155-1177.], and Demsetz and Villalonga, [Demsetz, H., Villalonga, B., 2001. The ownership structure and corporate performance. Journal of Corporate Finance 7, 209-233.]. Finally, we document that the speed of adjustment of insider ownership is positively related to insiders' market timing but negatively to the number of insiders and that the speed of adjustment of Tobin's Q is positively associated with financial leverage and stock price volatility. (c) 2006 Elsevier B.V. All rights reserved