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The number of large-block owners and the total percentage of the company's shares that they own define ownership concentration. Large-block shareholders are investors who typically own at least five percent (5%) of the company's shares. Diffuse ownership (characterised as a large number of shareholders with smallholdings and few, if any, large-block shareholders) produces weak monitoring of managerial decisions.

 

The greater the extent to which ownership of a company is concentrated, with large blocks of shares held by a few shareholders, the greater the incentive of the company's owners to monitor and control managerial actions. Shareholders' incentive to monitor is small when shareholders own few shares of stock--ownership are diffused--or when their investments are well diversified. While all shareholders bear the cost of monitoring, shareholders benefit from monitoring to the extent of their ownership. Owners of large blocks (whose investments are not diversified) have the greatest interest in monitoring.

 

Monitoring is important because it may encourage managers not to over diversify the company's portfolio of products and/or businesses. Weak monitoring may result in diversification beyond the preferences of shareholders. High or strong levels of monitoring may encourage managers to avoid excessive levels of diversification. Another result of monitoring is that it also may hold down the level of top management compensation (as a result of limiting diversification and, in turn, limiting the size of the company). Research indicates that ownership concentration is associated with lower levels of company diversification.

 

Monitoring usually is accomplished by the company's board of directors (who are elected by and charged with protecting the interests of shareholders by monitoring managers). Because large-block shareholders have more influence over the election of directors, companies with diffuse ownership are likely to be characterised by shareholders who have little incentive to gather extensive knowledge about individual directors (that are nominated by the company's managers) and who have less influence on the election of directors. Thus directors are likely to be more responsive to the preferences of large-block shareholders than they are to shareholders with smaller, less significant ownership interests.

 

In recent years, large block ownership by individuals has declined, but they have been replaced by significant positions held by institutional shareholders. Institutional shareholders are large block shareholder positions controlled by financial institutions, such as stock mutual funds and pension funds.

 

The importance of institutional shareholders is indicated by the fact that this shareholder group now controls over 30% of the shares in large companies. The emergence of large-block institutional shareholders who are taking aggressive action against managers of poor performing companies is increasing but is nowhere near the actions taken in the developed countries, especially US.

 

This could be due to the fact that institutional owners historically were restricted as to how they could exercise the power that accrued to them through their large block ownership positions and were basically passive investors. Although institutional investors were limited in their ability to directly influence the strategic decisions and actions of a company's top managers, they often could influence those actions indirectly. As shareholders, institutional investors vote on persons nominated to serve on the company's board of directors. They were able to gain the direct attention of the company's board members and indirectly influence the board's monitoring of managers.  They did this by individually casting their significant blocks against actions submitted to the shareholders for approval (by withholding their votes to prevent passage of actions they do not favour) or casting their votes as a single block (because of recently eased restrictions).

 

Managers are critical of these recent changes.  Comments range from shareholders "micro-managing" the company to concerns that top-level managers may become more risk averse and implement lower risk strategies or that they may seek employment protection.