CEO Share Ownership and Firm Valuation

We estimate the relation between Tobin’s Q and CEO share ownership with firm and CEO-firm fixed effects. Our results reveal an inverted U-shaped relation only when external pressure for good governance is weak, where the pressure is measured by product market competition and institutional ownership concentration. The inverted U-shaped relation seems to be a manifestation of some CEOs capturing the incentive contracting process under weak external governance. When external governance is strong, CEO share ownership is unrelated to Tobin’s Q, which is consistent with the predictions of principal-agent models. Our results are robust to various alternative explanations based on variable definitions, different statistical properties of the ownership variables under strong and weak external governance regimes, reverse causality, and time varying omitted variables. March 31, 2009: Preliminary draft. Please do not quote without the authors’ permission. Comments and suggestions are welcome. 1 Both are at Ross School of Business, University of Michigan, Ann Arbor, Michigan 48109. Email: [email protected] and [email protected]. We have benefitted from helpful comments and suggestions from Sugato Bhattacharyya, Amy Dittmar, Luo Jiang, Jin-Mo Kim, John McConnell, Adair Morse, Amiyatosh Purnanandam, and participants at finance seminar and corporate strategy seminar at University of Michigan, finance seminars at Rutgers University and State University of New York at Buffalo; and the 2008 China International Conference in Finance. We acknowledge financial support from Mitsui Life Financial Research Center at the University of Michigan.