OWNERSHIP STRUCTURE AND CONTROL The ... - Science Direct

Journal

of Financial

Economics

16 (1986) 73-98.

OWNERSHIP

North-Holland

STRUCTURE

AND CONTROL

The Mutualization of Stock Life Insurance Companies* David MAY ERS University of California, Los Angeles, Los Angeles, CA 90024, USA

Clifford W. SMITH,

Jr.

University of Rochester, Rochester, NY 1462 7, USA Received

February

1984, final version received March

1985

We examine an unusual sample of firms within the life insurance industry: 30 firms which switched from a common-stock to a mutual-ownership structure. Our evidence indicates that the rate of growth of premium income from policyholders remains unchanged, stockholders receive a premium for their stock, and management turnover declines; thus, no group of claimholders systematically loses in the sample of firms which choose to go through the mutualization process. We therefore conclude that for this sample of firms, changing from a stock to a mutual-ownership structure is on average efficiency-enhancing.

1. Introduction The insurance industry contains both stock and mutual firms. In a stock insurance company the common stockholders are the residual claimants of the corporation; they receive the benefits of good operating results and bear the costs if results are poor. Moreover, stockholders and policyholders are generally separate. In a mutual, however, the stockholder and customer functions are merged. Policyholders are the residual claimants although their ownership rights are limited. Mutuals typically charge a substantial premium at the beginning of the policy period but pay a dividend at the end. With favorable investment or claims experience, dividends are increased while with unfavorable experience, they are reduced. (Note, the IRS treats dividends paid on an insurance policy as a return of premiums and therefore a non-taxable distribution to policyholders.) *We thank H. DeAngelo, C. Holdemess, M. Jensen, R. Masulis, G. Oldfield, E. Rice, R. Roll and E. Fama (the referee) for their comments. This research was partially supported by the Managerial Economics Research Center, Graduate School of Management, University of Rochester.

0304-405X/86/$3.5001986,

Elsevier Science Publishers

B.V. (North-Holland)

74

D. Muyers and C. W. Smith, Jr., Muiualization

of stock life insurance companies

Several previous empirical analyses have examined the relative efficiency of stock versus mutual-ownership structures. Without exception, these cross-sectional studies conclude that mutuals are less efficient than stocks. For example, Nicols (1967) and Spiller (1972) argue that management converts its position in a mutual into personal gain at the expense of the firm’s other claimholders. O’Hara (1981) concludes: ‘Stocks appear more cost efficient, profitable, and beneficial to stockholders.’ Finally, Frech (1980) concludes: ‘Examination of the actual property rights structure of mutual insurers indicates that their . . . owners do not have full property rights. Thus they are expected to perform less efficiently than stock insurers, and that expectation is borne out.’ In contrast to these studies, the analysis in Mayers-Smith (1981, 1982) and Fama-Jensen (1983) is consistent with the potential efficiency of the mutual form of organization and an observed distribution of ownership structures including both stock and mutual firms. As Schwert (1981) argues, a more powerful test of the hypothesis that mutuals are potentially efficient would focus on time-series evidence from firms which switch from common-stock to a mutual-ownership structure, that is, mutualize. Ideally, the mutualizations would be recent, voluntary and would occur in stable regulatory and tax environments. We examine a sample of thirty firms within the life insurance industry that mutualized. Unfortunately, our sample is not recent - the earliest is initiated in 1879 and the most recent in 1968. Moreover, some of the mutualizations are apparently involuntary and some are motivated by tax or regulatory considerations. We discuss our sample, the available evidence on motivations and the potential for problems in interpreting our results. We believe the potential problems are not serious. To test the implications of the different theories of the efficiency of mutuals, we analyze the changes in stock prices, premium income, and management turnover that accompany mutualization. Our analysis provides evidence on the potential efficiency of mutuals and the existence of relative advantages that lead to the observed distribution of ownership structures. Additionally, since different ownership structures imply differential effectiveness of various corporate control mechanisms such as tender offers, proxy fights, internal and external labor markets, and capital markets, our analysis also suggests relative advantages of various mechanisms in the market for corporate control. Overview. In section 2, we discuss the incentives which lead to stock and mutual-ownership structures. We explain the mutualization process, discuss our sample, and present two alternative hypotheses explaining mutualization; we call them the expropriation and efficiency hypotheses. The efficiency hypothesis implies a positive change in the value of the firm. The expropriation hypothesis implies that the ownership structure change is motivated by wealth transfer opportunities and has a non-positive impact on the value of the firm. In section 3, we examine the evidence on wealth transfers among the three major claimholders - stockholders, policyholders, and managers - to test the

D. Muvers and C. W. Smrth, Jr., Muiualizatlon of stock hfe utsurunce compnnres

75

alternative hypotheses. In section 4, we disaggregate the sample of firms and examine in more detail evidence on gains in mutualization and implications for the effectiveness of specific mechanisms in the market for corporate control. In section 5, we present our conclusions. 2. Alternative 2.1. Contracting

ownership structures and mutualization costs and ownership structure

We analyze the incentives faced by the organization’s claimholders and the differing costs of controlling suggest that, across lines of insurance, incentive conflicts between residual claimants and managers, and between policyholders and residual claimants lead to different ownership structures [see Mayers-Smith (1981, 1982)]. Policyholders pay premiums in return for a Policyholder-stockholder conflicts. promise to receive a contractually agreed amount from the assets of the insurance firm on the occurrence of a specified event (e.g., death or disability). Thus, in common-stock life insurance companies, policyholders face incentivecontracting problems with insurance contracts which are similar to those faced by lenders with bond contracts. Stockholders of an insurance company have incentives to increase the value of the stock at the policyholders’ expense after the policies are issued. For example, if insurance policies are priced assuming the firm will maintain its past dividend policy, their value is reduced by unexpected dividend increases financed by reductions in assets. Similarly, the value of the stockholders’ equity rises and the value of the policyholders’ claims is reduced if the firm substitutes high-risk for low-risk assets. [For further elaboration, see the discussion in Smith-Warner (1979) of the agency costs of debt.] Of course, policyholders recognize the incentives faced by the firm’s other claimholders. Rationally priced insurance contracts reflect unbiased estimates of the firm’s expected investment, dividend, and financing policies. Thus, stockholders have incentives to seek ways to reduce the costs associated with this conflict of interest. The incentive conflict between policyholders and stockholders is more severe with long-term than with short-term policies. Thus firms which issue whole-life policies or long-term (e.g., 20-year term) policies have more opportunities over the life of the contract to change dividend investment or financing policy to the detriment of the existing policyholders. The stockholders’ actions are limited by the policyholders’ option to cancel the policy or, in the case of whole-life policies, to take out a policy loan. But these are imperfect disciplining mechanisms because of the ‘lock-in’ effect of long-term life insurance policies. Policy premiums are set as a function of the insured’s age when the policy is initially purchased. Five years after a 20-year term policy has been purchased,

76

D. Mayers and C. W. Smith, Jr., Mutualiration of stock life insurance companies

cancellation imposes significant costs. Thus, policy loans allow the policyholder to withdraw the savings component of a whole-life policy from the control of the firm, but the term component remains. One way in which the costs of the conflict between policyholders and stockholders can be reduced is with mutual ownership. In a mutual insurance company, the policyholders are the residual claimants of the firm. The rights of the policyholders of a mutual are not equivalent to the sum of the rights of the policyholders and stockholders of a stock insurance company. Their ownership rights are limited through the company charter, policy provisions, and regulation. There has been a serious debate over the implications of these limitations on ownership rights and the degree to which policyholders effectively control mutuals. [See, for example, Hetherington (1969) and Kreider (1972) who argue that mutuals are controlled by incumbent management, and Anderson (1973) who disagrees.] But even if policyholders of a mutual do not have all the rights of both policyholders and stockholders of a stock insurance firm, mutual ownership still eliminates the stockholder group with its separate and sometimes disparate interests. This reduces potential costs imposed on policyholders from the choice of dividend, financing and investment decisions over the lives of their policies. We believe that this is the major benefit of the mutual form of organization. The owner-manager conflict. In a stock insurance company, the threat of an outside takeover is a significant factor in reducing the costs management can impose on the firm’s other claimholders. If management decisions impose too many costs, tender offers can discipline managers. [Tender offers are one transaction in what Manne (1965) calls the market for corporate control. See Jensen-Ruback (1983) for a review of the theory and evidence on the market for corporate control.] In a mutual, this control mechanism is eliminated; the purchase of control is precluded because ownership claims are not separable from the insurance policies. The policyholders would have to remove the existing management through a proxy fight, but proxy fights are more expensive in mutuals than in stock firms. For example, courts have ruled that a mutual insurance firm can refuse to provide a list of policyholders even if the cost of producing the list is reimbursed. [For a description of the costs of waging a proxy fight for control of mutual insurance firms, see the report of the Temporary National Economic Committee (1940, pp. 14-27).] Therefore, it is generally more expensive to form effective competing control coalitions in mutuals than in stock firms because one potential control mechanism (the tender offer) is eliminated and another (the proxy fight) is more expensive. In other words, the market for corporate control typically is less effective when insurance companies are organized as mutuals because of the higher costs of transferring control. Finally, mutual-ownership structures impose an additional cost by merging customer and owner roles; common-stock firms allow

D. Mayers and C. W. Smith, Jr., Mutualization


71

more efficient riskbearing through stockholder specialization [see FamaJensen (1983)]. These are costs of the mutual form of organization. Therefore, if mutuals are efficient, the more severe incentive problems between residual claimants and managers of the firm and the loss in riskbearing efficiency must be offset by the advantages of a mutual in controlling the incentive contracting problems between policyholders and stockholders.

2.2. The competing

hypotheses:

Eficiency

versus expropriation

The mutualization process alters the incentives of the individual contracting parties and can result in a change in the value of the firm. The efficiency hypothesis implies that for the mutualizing companies the benefits outweigh the costs. A sufficient (although not necessary) condition for the value of the firm to increase through mutualization is that each of the classes of claimholders gains. However, the mutualization process also offers the potential for wealth transfers or expropriations. A necessary (but not sufficient) condition for mutualization to reduce efficiency is that one of the classes of claimholders systematically loses in the process. Finally, the fact that stockholders, policyholders, and managers each have to agree to the mutualization plan, suggests that each group of claimholders should be made better off by mutualization, and this implies the efficiency hypothesis. We examine implications of mutualization for policyholders, stockholders, and managers to test these hypotheses.

2.3. The mutualization

process

Mutualization is a legal procedure (specified in the various states’ insurance statutes) by which a common-stock insurance firm can change ownership structure and become a mutual. Although insurance codes vary in their requirements for mutualization, the statutes generally contain provisions stipulating the following: (1) For a stock company to mutualize, stockholders, policyholders, board of directors, and state insurance commissioner all must agree. What ‘all must agree’ means is dictated by the statute; usually it means a majority of those voting must approve. (2) While the entire stock of the company is being purchased, stock previously acquired must be held in trust. (3) Some states also specify conditions under which the mutualizing company can force the sale of dissenting minority stockholdings. The basic instrument of the mutualization process is the plan of mutualization. The plan generally must be approved by the state insurance commissioner. Typical plan provisions include: (1) the schedule of payments to stockholders; (2) the interest rate to be paid on any balance owed stockholders; (3) naming of trustees to hold acquired stock and specification of a replacement procedure; (4) constraints on payments (sources of payments,

78


limitation on surplus, anticipated changes policies); and (6) the also Dawson (1917),

2.4.


how money is segregated for untendered shares); (5) any in operations (e.g., to cease selling non-participating procedures for concluding the mutualization process [see Gold (1975), Fletcher (1964, 1966) and Zartman (1907)].

The mutualized life insurance companies

Table 1 lists the thirty stock life insurance companies which mutualized, their location, date of formation, and the years mutualization was initiated, approved and completed. The sample is, as near as we can tell, exhaustive. Also, we found no firms where mutualization, once initiated, was uncompleted. Our sample of firms is taken from Stalson (1942), Fletcher (1964, 1966), Bests’ Life Insurance Reports, and Spectator. Fletcher (1964, 1966) discusses reasons for mutualization for twenty-six of the companies in our sample. Her evidence was obtained by personal interview and by reviewing various records such as minutes of the companies’ board of directors meetings, legal decisions and court records. Only one company, Provident Mutual, gave as its reason a change in the tax environment. Prior to Provident’s mutualization, ‘mutual companies were paying a substantial personal property tax based on assets, to which stock companies were not subjected . . . this law was exactly reversed. Stock life insurance companies were then compelled to pay personal property taxes, and, at the same time, the mutual life insurance companies . . . were relieved of the obligation’ [Fletcher (1966, p. 30)]. The only potentially motivating legislation mentioned by Fletcher (1964, 1966) were certain ‘remedial’ measures in the New York Insurance Laws of 1906. The remedial measures ‘eliminated non-dividend profit opportunities of all life insurance companies operating in New York State’. Non-dividend profit opportunities include such things as interest-free loans and ‘substantial’ salaries for stockholder officers/directors. While she indicates the legislation as important for the mutualization of Metropolitan Life, Equitable of the U.S., and the Prudential, she also cites adverse public opinion as the primary reason for these companies’ mutualization. Since the first of these mutualizations was initiated eight years subsequent to the passage of the laws, we doubt this legislation was the only important factor for the mutualization decisions of the three companies. Four of the firms (General American, Kentucky Home, Pacific Mutual, and Victory Life) were mutualized at the time of or following a reorganization. It is likely that these four mutualizations were not entirely voluntary. For example, the state insurance commissioners are likely to assume a more prominent role in the process for these firms. However, the involuntary nature of a mutualization does not eliminate an underlying efficiency or expropriation motivation. Thus, we see no obvious bias from including these firms in the sample. The

stock life insurance

Bankers Life Insurance Company of Nebraska Canada Life Assurance Company Central Life Insurance Company Confederation Life Association Equitable Life Assurance Society of the United States Equitable Life Insurance Company of Canada Farmers and Traders Life Insurance Company Federal Life Insurance Company General American Life Insurance Company Guardian Life Insurance Company of America Home Life Insurance Company Industrial Life Insurance Company Kentucky Home Mutual Life Insurance Company Manufacturers Life Insurance Company Metropolitan Life Insurance Company

Name of company

Mutuahzed

companies,

1920

Ontario New York

Waterloo, Syracuse,

1860 1905 1932 1887

New York, New York Sillery, Quebec Louisville, Kentucky Toronto, New York, New York

1867

1860

New York, New York

Ontario

1899 1892

Chicago, Illinois St. Louis, Missouri

1913

1847 1896 1871 1859

1887

Formation date

Toronto, Ontario Des Moines, Iowa Toronto, Ontario New York, New York

Nebraska

Location

year in which mutualization

Table 1 year of formation,

Lincoln,

location,

Initiated

1914

1958

1916 1968 1934

1924

1945 1936

1953

1958

1958 1919 1958 1917

1941

approved

1915

1958

1916 1969 1935

1924

1945 1936

1954

1958

1959 1919 1958 1918

1941

Approved

1915

1963

1916 1969 1935

1945

1962 1946

1974

1963

1962 1919 1968 1925

1949

Completed

was

and completed.

Year in which mutualization

was Initiated,

1921 1914 1934

1865 1873 1914

Portland, Oregon Montreal, Quebec

Standard Insurance Company Sun Life Insurance Company

of Canada Union Central Life Insurance Company Victory Mutual Life Insurance Company Western and Southern Life Insurance Company

1889

1851

1867 1923 1888

Cincinnati, Ohio Chicago, Illinois Cincinnati, Ohio

1946

1933

1941

1929 1958

1943

1911

1906 1865

1946

1867

Los Angeles, California New Orleans, Louisiana Hartford, Connecticut Philadelphia, Pennsylvania Newark, New Jersey Roanoke, Virginia

1879 1941

1936

l-955

1857 1909

1909

1947

1933

1947

1929 1958

1914 1934

1922

1889

1943

1950

1879 1948

1936

1956

Approved

1948

1933

1954

1929 1962

1943 1955

1922

1889

1952

1959

1879 1959

1949

1956

Completed

Year in which mutualization was Initiated

Montpelier, Vermont Cincinnati, Ohio

1905

Madison, Wisconsin

Formation date

Columbus, Ohio

Location

National Life Insurance Company Ohio National Life Insurance Company Pacific Mutual Life Insurance Company Pan American Life Insurance Company Phoenix Mutual Life Insurance Company Provident Mutual Life Insurance Company Prudential Insurance Company _ _ of American Shenandoah Life Insurance Company

Company

Midland Mutual Life Insurance Company National Guardian Life Insurance

Name of company

Table 1 (continued)

Z’ f E 0 R 2 f: E’ -

5 8: % 9 : z : %

3 F,

;>

2 3

: iT:

B

B 8



81

worst likely effect of including them would be that they add noise to the experiment. Other major categories of reasons mentioned by Fletcher (1964, 1966) include estate tax problems (four companies) and to prevent outside control (eight companies). Other minor reasons include such things as disagreement among stockholders (four families owned 96 percent of the outstanding shares), a stockholder-manager conflict over the line of business, and a change of ‘its legal structure and its German name because of the anti-German sentiment . . . following World War I’ [Fletcher (1966, fn. 5)]. Thus the potential nominal reasons for mutualization are many. However, the reasons given are all of the type that could simultaneously exist with an underlying efficiency or expropriation motive and they do not appear to be the kinds of reasons that would cause serious bias in our study. One other feature about our sample is deserving of mention. Note, in table 1, that the rate of mutualization has not been uniform over time. Some of the bunching of dates reflects the passage of mutualization laws. Nine of the firms initiated mutualization within one year of the passage of the authorizing law (Canada Life, Confederation Life, Equitable of Canada, Manufacturers Life, Provident Mutual, Prudential, Shenandoah Life, Sun Life, and Victory Mutual).

3. The evidence: Efficiency versus expropriation Mutualization frequently specify thit shares ments a period of years. The frequency with completion plan takes more than ten years primarily reflects that implementation Thus at approval, stock is exchanged bonds promising take up to thirty years initiation plan. We present evidence on the impact of mutualization each of the firm’s claimholders. types of policies lapse ratios after the approval While policyholders most obvious potential also assess the effect on stockholders they receive over the stock after the approval

82

D. Mayers and C. W. Smith, Jr., Mutualiration

of stock lije insurance companies

3.1. Changes in premium income If the firm’s insurance policies become less attractive to its customers, any reduction in the value of outstanding policies should be associated with a decline in policy renewals or new sales; both imply a reduction in the insurance company’s premium income. While there are arguments that can be offered in which changes in premium income is a poor measure of policyholder welfare, most of the arguments require non-competitive insurance markets. We believe that the life insurance industry is best analyzed as competitive in the sense that life insurance firms are price-takers. In 1983 there were 2048 firms licensed to sell life insurance in the United States [Institute of Life Insurance (1983)]. Although a large number of firms and effective competition are not synonymous, we believe that the case for effective competition is quite strong with the addition of evidence of low barriers to entry (e.g., the annual number of new entrants over the past thirty years ranged between 50 and 216). Additionally, there is little evidence of marginal firms earning rents (e.g., the annual number of exiting firms over the past thirty years ranged between 11 and 104). Table 2 shows that the average annual percentage change in premium income for the ten years prior to approval of the mutualization process was less than that for the ten following years (5.73% versus 7.38%). Thus, if we assume that the change in premium income is a stationary time series, the data suggest that mutualization is associated with higher insurance sales. To correct for potential non-stationarity in the data, we also calculate industry-adjusted premium-income changes. We subtract from each company’s annual percentage change in premium income the corresponding annual percentage change in average premium income for the industry. We find that the average percentage change in industry-adjusted premium income for the mutualizing firms for the ten years prior to the approval of the mutualization process is not significantly different from that for the ten years after (3.87% versus 3.62%). Since both measures suggest the growth in premium income subsequent to the mutualization approval was on average no lower than prior to the approval, we conclude that expropriation of policyholder wealth is not the dominant motive for mutualization. Product mix changes. One possible problem with the table 2 evidence is that mutualizing firms change their product mix and that the types of policies issued subsequent to approval generate greater premium income. For example, the premiums generated by whole-life policies should be larger than for term policies because of the savings component of whole life. Thus systematic shifts in the product mix for mutualizing firms could be masking evidence of policyholder expropriation.

D. Mayers and C. W. Smth,

Jr., Mutualiration


83

Table 2 Average percentage changes in premium income and industry-adjusted premium income for years relative to the approval of the mutualization process. The percentage changes are averaged across the firms in the sample. Percentage change in industry-adjusted premium income is calculated by subtracting the percentage change in average premium income for the industry from the percentage change in premium income for the firm, then averaging across the firms in the sample. Average Average industry-adjusted Year relative to % change in Number % change in the approval of premium income’ premium incomeb of firms” mutualization ~ 10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 AVG( - 10, ~ 1) AVG(O.9) Difference r-statistic

29 29 30 30 30 30 30 30 30 29 29 30 30 30 30 30 30 30 30 30

4.40 5.10 9.08 9.23 1.71 1.43 5.44 1.96 2.86 4.04 5.12 9.57 6.36 6.72 7.46 9.09 9.25 6.28 5.89 8.05

4.36 5.82 8.46 9.06 4.24 6.12 2.76 - 0.51 - 2.64 1.02 1.30 5.09 2.50 3.83 3.68 5.78 5.94 3.15 2.16 2.17

5.73 7.38 + 1.65 1.93

3.87 3.62 -0.25 -0.18

“The missing observations are from Victory Life. bAnnuaf premium-income data for the mutualizing firm was obtained from Best’s Life Insurance Reports and Spectator. ‘Annual premium income data for the life insurance industry was obtained from Eesr’s Life Insurance Reporrs and Spectator; the number of life insurance companies in each year was obtained from Stalson (1942) and The Life Insurance Fact Book.

As a check we collected the additional evidence, summarized in table 3, on the product mix of the mutualizing firms five years before and five years after mutualization approval. Five years prior to approval the average mutualizing firm (sample of nineteen firms) was already doing half of its business in participating policies and in the subsequent ten years increased the percentage to 52.26. The average difference (2.24%) is not significant. Looking at the distribution of business among whole-life/endowment, term-life (long-term and short-term contracts) and group policies, we find what

84



Table 3 Product (1)

Distribution

mix five years before and after the approval of (business\between I non-participating\and) nineteen mutualizing firms Non-participating

5 years before 5 years after Difference t-statistic (2)

Distribution

participating(policies:

%

of business

b Average

for %

50.02 52.26 2.24

between whole-fife/endowment, term, and group for seventeen mutualizing firms

78.54 65.23 - 13.31 - 5.16’

processa

Participating

49.98 41.14 - 2.24 - 0.60

Whole-fife endowment % 5 years before 5 years after Difference t-statistic

of the mutualization

Term-life 9.64 11.51 1.87 1.16

%

policies:

Average

Group

‘%

11.82 23.24 11.42 3.68’

“Product-mix percentages are obtained using year end insurance in force numbers from Best’s Life Insurance Reports. The companies included in these samples are the more recent mutualizations. Early Best’s Life Insurance Reports included only statements such as: ‘The company writes both participating and non-participating policies.’ bParticipating policies pay dividends and non-participating do not. ‘Significant at 0.05 level or better.

appears to be evidence of a systematic shift for a sample of seventeen firms. Five years prior to approval 78.54% of business was on average in whole-life and endowment contracts. This percentage was reduced to 65.23 by five years after approval and the difference (-13.31%) is significant. However, the seventeen firms in the sample are all more recent mutualizations (the data was unavailable for the older ones). The correlation between the individual firm differences (W five years after minus 5%five years before) and the year of mutualization approval is a significant - 0.69. Moreover, over this period there has been substantial growth in the use of group policies. When we adjust the group-policy percentages for the mutualizing firms by industry average percentages in the corresponding periods, we find that the industry-adjusted differences are insignificant. Thus interpreting what we find as an industry effect, we assess there is no significant industry-adjusted shift in the product mix of long-term and short-term contracts. And, of course, our premiumincome evidence is industry-adjusted. The evidence on changing product mix is consistent with the hypothesis that the mutualizing firms were operating as if they were mutuals prior to the mutualization approval (at least with respect to product mix).

D. Mayers and C. W. Smith, Jr., Mutualization of stock life insurance companies

85

Potential wealth transfers among policyholders. It is also conceivable that policyholders are differentially affected by mutualization. For example, the evidence in table 2 is also consistent with the hypothesis that mutualization hurts old policyholders while benefiting new policyholders. There are three facts which reduce the plausibility of this explanation: (1) For the subsample of thirteen firms where actual policyholder votes are reported by Fletcher (1966), the average percentage of policyholder votes cast against mutualization is 1.29%. (2) Of the thirty mutualizations we examine, only three were challenged by policyholder lawsuits; in all three cases, the courts rejected the policyholders’ claims. (3) The state insurance commissioner generally supervises the policyholder voting process and also must approve the mutualization plan. As an additional check, we examine average lapse ratios and average industry-adjusted lapse ratios around the year of the mutualization approval. Lapse ratios are measures of the proportion of total business that is terminated for other than death claims and matured endowments in a given year. Thus an increase in the lapse ratios during the approval and subsequent years would be consistent with mutualization hurting the old policyholders. Note, however, that if the ‘lock-in’ effect imposes a large penaity, as it may have especially during the early period of our analysis, lapse ratios could be relatively insensitive to policyholder dissatisfaction. None-the-less, table 4 shows that the average annual lapse ratios and average industry-adjusted lapse ratios are not on average larger during the approval and following five years. For example, the industry-adjusted lapse ratio averaged 1.0% for the five years prior to approval and 0.75% for the subsequent five years. The lack of evidence of a change in product mix and the evidence for no observable differential effect between old and new policyholders supports our conclusion that expropriation of policyholder wealth is not the dominant motive for mutualization. 3.2. Stock purchase premiums Table 5 contains the evidence on the premiums stockholders receive for thirteen of the thirty companies for which data could be found. This evidence implies significant premiums are paid to stockholders. The 75% average rate of return can be compared with the Standard and Poor’s Composite Stock Price Index which averaged 18% over the same event years; hence the average premium for this sample is approximately 57% (75% - 18%). This suggests that wealth transfers from stockholders are not the motivation for the typical mutualization. The 18% return to the S&P Index is based on closing index values for the year of and the year prior to the mutualization announcement and is thus an

J.F.E

E

86

D. Muyers and C. W. Smith, Jr., Mutualizarion of stock life insurance companies

Table 4 Average lapse ratios and industry-adjusted lapse ratios for years relative to the approval of the mutualization process. The lapse ratios are averaged across the firms in the sample. Average industry-adjusted lapse ratios are calculated by subtracting the industry lapse ratio from the firm lapse ratio, then averaging across the firms in the sample!

Year relative to the approval of mutualization -5 -4 -3 -2 -1 0 1 2 3 4 AVG( - 5, - 1) AVG(O,4) Difference t-statistic

Average industry-adjusted lapse ratio (%)

Number of firms

Average lapse ratio (%)

24 26 26 25 26 26 23 25 26 26

9.11 9.26 10.19 9.96 9.31 8.92 8.09 8.02 8.78 9.77

1.09 0.71 1.52 1.21 0.47 0.45 - 0.28 0.22 1.02 2.20

9.57 8.74 -0.83 -0.96

1.00 0.75 -0.25 - 0.36

“Lapse ratio data was located for twenty-seven of the thirty firms in Best’s Life Insurance Reports and Spectator. Best’s lapse ratios include lapses after the first year and are defined as the ratio of the amount of ordinary life insurance terminated (except for death claims and matured endowments) to insurance in force at beginning of the year plus prior years new business issued. Spectator lapse ratios are calculated as the ratio of dollars paid for lapsed, surrendered and purchased policies to premium income. Industry lapse ratios were obtained from Spectator and The Life Insurance Fact Book. The Spectator industry lapse ratios are calculated as above (for Spectator) from industry aggregates for firms reporting doing business in New York. The Fact Book industry lapse ratios are defined as the ratio of the number of ordinary policies surrendered or lapsed to the mean number of policies in force during the year.

annual rate of return. The 75% average rate of return is probably an understatement: the average period over which the rates of return are calculated is less than one year, and in four cases we use the reported high for the prior year as the prior price. The only case where there is obvious potential for overstatement is in Confederation Life’s post price. Here we use the reported high for the mutualization announcement year as the post price. We use this price because it is lower than our calculation of the present value of the redemption payments. We believe the high is a better estimate of the post price than the low. The average rate of return is reduced from 75% to 70% using the low from the mutualization announcement year for Confederation Life. Of the thirteen companies reported on in table 5, Midland Mutual Life stands out as atypical. With a $1000 per share tender offer outstanding the directors voted and a majority of the shares approved a mutualization plan that paid the shareholders $200 per share. (Note, however, the $1000 tender

D. Mavers and C. W. Smith, Jr., Mutualization

of stock life insurance compames

87

Table 5 Stock prices prior to and post mutualization announcement for subsample with available data. Where only price ranges were available, the highest prior price and the lowest post price were employed to derive a conservative estimate of the rate of return. Announcement and approval year”

Company Canada Life Confederation Life Equitable/US Equitable/CAN Farmers & Traders General American Industrial Life Metropolitan Life Midland Mutual National Guardian Pan American Shenandoah Life Sun Life Average Average

of available of available

1959 1958 1917 1958 1954 1936 1968 1914 1955 1936 1943 1934 1958 rates of return rates of return without

Prior price (S) 2OO.OOb 140.00’ 4OO.OOb 50.00’ 750.OOd 55.OOd 20.00= 45X@ lOOO.OOb 80.00’ 13.75d 6.00b 2OO.OOd

Midland

Post price (S)

Rate of return (%)

220.c@ 167.00c~s 15OO.OO+-=h 52.50’.’ 850.00d 58.06bsf 43.00c,e* 75.OOb.’

10.0 19.3 275.0 5.0 13.3 5.6 115.0 66.7 - 80.0 175.0 109.1 191.7 66.3

;;:;bh:: 28.75d 17.50b 332.50d

74.8 87.7

“For each of these firms, the announcement year, initiation year, and approval year coincide. b Source: Fletcher (1964). Unless indicated otherwise the price used is a market price. ‘Source: Moody’s Moody’s reports the high and low price for the year. With the Moody’s source, the high from the year prior to the mutualization announcement is used as the prior price. d Source: Bunk and Quotation Record. The mean of the bid and ask is used. e The price is the cash redemption payment of a single-purchase redemption plan. ’ The price is our calculated present value of the company’s installment redemption payments. We used the long-term corporate bond rates as reported in Ibbotson-Singuefield (1982) for discounting. g The price is the reported high for 1958 (the low was $87) which was lower than our calculation for the present value of the redemption payments ($169.80) (see also text). h The price is the cash redemption payment paid to others than T. Coleman duPont who received $5400 per share for his controlling block. I The price is the reported low for 1959.

offer was challenged in court and it was not clearly a valid offer.) Eliminating Midland raises the average rate of return to 87.7%.

Comparison with other corporate control evidence. Our estimated premium is approximately equal to the 56% announced offer premium and is larger than the 30% measured abnormal stock price change reported by DeAngelo, DeAngelo and Rice (1984) in their study of firms which repurchase the entire outside equity of the firm and go private. It is also larger than the approximately 23% announced offer premium and 15% measured abnormal stock price change for general common stock repurchase announcements reported in Dann (1981), Masulis (1980), and Vermaelen (1981). The estimated premium

88


can also be compared to inter-firm transactions in the market for corporate control. Dodd (1980) reports a 24% average wealth increase for target stockholders in successful mergers, and Bradley (1980) reports a 40% average wealth increase for target stockholders in successful inter-firm cash tender offers. Therefore, the average premiums received by shareholders of mutualizing firms appear to be as large as those documented for other transactions in the market for corporate control. While the transactions we examine are most similar to the DeAngelo, DeAngelo and Rice (1984) study of going-private transactions, there is an important difference: in our sample, managers as well as outside shareholders sell their shares. This reduces the likelihood that mutualization is motivated by stockholder-expropriation incentives. This fact also allows us to reject the information hypothesis which DeAngelo, DeAngelo and Rice find troubling. The information hypothesis suggests that insiders have private information that implies an abnormal increase in firm value and that they purchase the minority outside stockholders’ shares (go private) at a price less than their expected future value. This hypothesis would explain price premiums paid to minority shareholders yet the value increase would not be caused by the going-private offer (rather the offer is caused by the price increase). Since in our sample management sells their shares, the information hypothesis implies they forecast abnormal decreases in firm value. Yet our evidence indicates average industry-adjusted premium-income growth rates are no lower after mutualization. Thus we conclude that the information hypothesis does not explain our sample of mutualizing firms. [Note, also, that the information hypothesis cannot explain going-private transactions if stockholders are rational. Manne (1964) and Bradley (1980) argue that shareholders have to be systematically better off by tendering their shares than by not tendering if the offer is to be successful. Thus, the theory tells us that if the information hypothesis were the motivation for going-private offers, they should systematically fail.] 3.3. Changes in management turnover We use management turnover as a metric for management welfare. In order to link management welfare with management turnover we must assume that managerial compensation packages are not instantaneously adjusted with the change in ownership structure. We also assume that turnover is costly to managers, perhaps, because of the existence of significant firm-specific human capital. Table 6 contains the number of chief executive officer (CEO) changes that occur in the ten years prior to and including the approval year, in the ten years after the approval year, and the stated reason for each change. The Chief Executive Officer was identified, for each year, as the top listed officer in A.M. Best Company’s Best’s Life Insurance Reports. Usually this officer was listed

89

D. Mayers and C. W. Smith, Jr., Mutualizarion of stock life insurance companies

Table 6 Number

of chief executive

Company Bankers Life Canada Life Central Life Confederation Life Equitable Life/US Equitable Life/CAN Farmers & Traders Federal Life General American Guardian Life Home Life Industrial Life Kentucky Home Manufacturer’s Life Metropolitan Life Midland Mutual National Guardian National Life Ohio National Pacific Mutual Pan American Phoenix Mutual Provident Mutual Prudential Shenandoah Life Standard Sun Life Union Central Victory Life Western & Southern Total Changes Category c and d Totals Difference

officer (CEO) changes Approval 1941 1959 1919 1958 1918 1958 1954 1945 1936 1924 1916 1969 1935 1958 1915 1956 1936 1879 1948 1950 1943 1889 1922 1914 1934 1929 1958 1947 1933 1947

year

prior and post mutuahzation Prior ( - 9,0) 0

approval.” Post (1.10) 0 lb 2~.d

lb 0

Id Id 0 0 0

0 1* 0 2d.g

3h.l.h 2e, g

0

Id 0 0 2h.d

1s $i,h.h,J 2d. s 0 1s 0 Id Id 1’ 0 lh 0 Id Id Id 1s 0 1’ 0 26 9 T7

0 0 0 Id 1s 0 0 0 Id 0 0 Id lC Id 0 0 0 0 Id 16 10 6

“Sources used to identify the reason for the CEO change include: Ashforth (1962), Besr’s Life Insurance Reports; Best’s Insurance New Life Edition, Bisbee (1925) Buley (1959), Davidson (1971). Kesslinger (1960) Marquis (1947), Moore (1928) Nunis (1968), and Who Was Who m America, Vols. I-IV (Marquis Who’s Who, Inc., Chicago, IL). The CEO non-death or illness related changes in each event year from - 9 to + 10 were: 1, 1, 3, 0, 0, 2, 1, 3, 3, 3, 0, 0, 0, 0, 0, 1, 0, 1, 3, 1. Of the three CEO changes that occurred in the year of the approval of the mutualization plan, two changes definitely occurred prior to the approval. In the other case the exact date is undetermined, however, the former President was successfully sued by the company’s Board of Directors for return of excessive dividends received while he was President. b Former CEO stayed with the company in a lesser position, ‘CEO resigned - no reason. d Change caused by incumbent’s death. ‘Resigned for health reasons - ‘acute case of Bright’s disease’. f Resigned in face of ‘ unscrupulous behavior’ charge. sCE0 stayed with the company as Chairman or member of the Board. h CEO change coincidental with control change. ‘CEO change coincidental with company being placed in receivership. JNo reason stated for change.

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as the President and in a few cases as the Chairman of the Board. In two cases we were able to identify the President as being the CEO even though the Chairman of the Board was listed first in Best’s. However, usually, when the Chairman of the Board was listed first and a change occurred, both the President and the Chairman of the Board changed so the identification problem should not be serious. If we eliminate those cases where the CEO died in office plus the one with an ‘acute case of Brights’ disease’, there are a total of seventeen CEO changes that occur in the thirty companies during the ten years prior to and including the approval year. There are only six changes during the subsequent ten years. Based on this evidence, the probability of a non-health-related CEO change prior to the approval of the mutualization process was three times as great as the probability of one afterward. We realize this is not strong evidence. Salary histories for the executives before and after mutualization would more directly link the welfare impact. Unfortunately, this kind of evidence is not available. But, with our assumptions, the turnover evidence is consistent with the existence of benefits for the management team at the time of mutualization approval. It is also, and perhaps more strongly, consistent with the hypothesis that the market for sorporate control is a less effective disciplining mechanism subsequent to approval.

3.4. Summary We present strong evidence of gains for stockholders, weak evidence of gains for managers, and no evidence of policyholder losses. Thus we conclude that mutualization by this sample of firms is more consistent with the efficiency hypothesis than the expropriation hypothesis. This conclusion is also consistent with rational voting since the mutualization plan is initiated by managers, and voted on by both stockholders and policyholders.

4. Corporate control implications and mutualization In this section, we provide additional evidence on the efficiency hypothesis and on the control implications of the mutualization process. An important aspect of mutualization is that the costs faced by competing management coalitions in the market for corporate control are altered: the effectiveness of the various mechanisms in this market change when the firm’s structure is changed. The hypothesis that managers are disciplined more effectively by the market for corporate control when the firm is organized as a stock company provides predictions about the impact of mutualization on the policyholders.

D. Mu~vers and C. W. Smith, Jr., Mutualization

of stock life insurunce cotvpames

91

4.1. Data classiJication and predictions While it generally should be cheaper to form an effective competing coalition for control of an insurance company if it is organized as a stock company than if it is organized as a mutual, the costs differ with the ownership distribution of the stock company’s shares. For example, if voting rights are vested solely in the common stock, and the president holds majority ownership, alternative coalitions are effectively constrained from competing for control of the firm. If a mutualization plan is carried out, the policyholders will have some (albeit small) potential for gaining control that did not exist before. As a consequence, mutualization can lower the costs facing a potential competing coalition in some cases. We group the thirty firms in our sample according to our assessment of the costs that a potential competing management coalition would have faced prior to mutualization if it had attempted to gain control of the firm. There are three groups: high cost, indeterminate cost, and low cost. In the high-cost group, there are three categories of firms: (1) the president owns a majority of the shares and thus holds blocking power; (2) the incumbent management team owns the majority of the common stock and thus has control through a coalition; and (3) contractual constraints exist that make it expensive for potential coalitions to compete effectively. The indeterminate-cost group consists of .those firms with a large non-management ownership concentration. Since arguments can be offered placing these firms in either the high-cost or low-cost category, we examine them separately. The third, low-cost, group consists of those firms that were effectively widely held, i.e., where no group appears to have blocking power. Our grouping is contained in table 7. Our assessment of costs for the various firms is obviously subject to error. A good example is the Standard Insurance Company. Shareholders were restricted by the corporate charter to holding a maximum of two shares. This constraint leads us to categorize Standard in the high-cost group. But there were only approximately eighty shareholders, all geographically concentrated in the Portland, Oregon area. In this case, we may have misassessed the costs facing a potential competing management coalition. For the firms with little ownership concentration (low-cost group) mutualization implies a greater reduction in the disciplining of management by the market for corporate control than in the management-controlled firms (highcost group). Thus, given the efficiency motivation for mutualization, benefits to policyholders should show up most clearly in the management-controlled firms and least clearly (or not at all) in firms with little ownership concentration. Alternatively, if expropriation is the motivation for mutualization, adverse effects could be more pronounced in either the management-controlled firms or the firms with little ownership concentration. In management-controlled firms, stockholders and managers face lower costs of colluding against policyholders. In the firms with little ownership concentration, costs imposed by the greater

Table I Groups

(1)

of sample companies based on assessment of the costs that a competing management coalition would have faced in attempting to gain control prior to mutualization.

High Cost to Forming

Effective Competing

Coalition

A. President with blockingpower Central Life Federal Life Phoenix Mutual Western & Southern

%president owns 52.0 70.0 50.1 95.0

Reference Letter from Central Life Fletcher (1964, p. 125) Fletcher (1964, p. 285) Fletcher (1964, p. 134)

B. Control in managemeni Bankers Life Guardian Life Metropolitan National Life Pan American Union Central

I% coalition owns 74.1 60.0 53.1 100.0 50.0 96.0

Reference TNEC #28 Letter from Guardian Life Fletcher (1964, p. 84) Bisbee (1925, p. 76) Fletcher (1964, p. 131) Fletcher (1964, p. 177)

coalition

C. Contractual constraints on coalitions Ohio National Pacific Mutual Standard

(2)

Indeterminate

Cost to Forming

Canada Life Equitable/US General American Kentucky Home Manufacturers Life Prudential Shenandoah Life (3)

Relatively

Low Cost to Forming

Confederation Lifek Equitable/CANk Farmers & Traders’ Home Life” Industrial Life”

Constraint voting trusta state regulationb corporate charter’

Effective Competing

Reference (1964, p. 166)

Moody’s_Best’s Letter from Standard, Fletcher (1964, p. 8)

Coalition

Outside ownership % 51d 56e 93’ 50s 45h 50’ 4oj Effective Competing

Fletcher

Fletcher Fletcher Fletcher Fletcher Fletcher Fletcher Fletcher

Reference (1964, p. (1964, p. (1964, p. (1964, p. (1964, p. (1964, p. (1964, p.

250) 99) 157) 151) 238) 109) 215)

Coalition

Midland Mutual’ National Guardiank Provident Mutualm Sun Lifek Victory Life’

“Automatically renewable voting trust held 70% of shares, but controlled by management. ‘Stock held by the California Commissioner of Insurance. ‘Provision of charter that no individual may hold more than two shares. d Owned by ‘a small group’, apparently not affiliated with management. e Owned by T. Coleman duPont and held in a voting trust, not apparently controlled by management. f Owned by Southwestern Investment Corporations, apparently not affiliated with management. gowned by Control Corporation, apparently not affiliated with management. hOwned by Gooderham Trust, apparently not affiliated with management. ‘Owned by Fidelity Trust which was largely controlled by the Prudential; but an attempted takeover by Fidelity Trust just prior to mutualization places it in this category. ‘Owned by Lehman Bros, apparently not affiliated with management. kThese companies gave as a rationale for mutualizing avoiding losing control to ‘speculative’ (or in the case of the Canadian companies - ‘foreign’) interests. ’ Mutualized to avoid takeover attempts by tender offer. mTo date we have no information of significant ownership concentration in these companies. “The company confirmed no significant ownership concentration. OMoody’s listed this company as having 1186 shareholders and 9000 shares outstanding.


93

Table 8 changes in premium income and industry-adjusted Averages of percentage process, ten years prior and ten years after the approval of the mutuahzation within cost groups.

Cost group

Number of firms

(1) High” AVG( - 10, - 1) AVG(O,9) Difference f-statistic

13

(2) Indeterminateb AVG( - 10, - 1) AVG(O,9) Difference f-statistic

I

(3) Low’ AVG( - 10, - 1) AVG(O.9) Difference t-statistic

10

Average % change

premium income for averaged across firms

Average industry-adjusted % change

4.30 8.39 + 4.09 4.3ld

1.95 5.08 +3.13 2.89d

3.66 6.03 + 2.31 1.40

2.31 2.29 ~ 0.01 ~ 0.01

9.09 7.02 - 2.01 -1.14

1.53 2.66 ~ 4.81 ~ 2.34d

“High cost to form effective competing coalition because (1) president has blocking power, (2) management coalition has blocking power, or (3) are contractual constraints to effective competing coalitions. bFirms have high ownership concentration in non-management hands. ‘No significant ownership concentration. dSignificant at 0.05 level or better.

reduction in the disciplining of managers could outweigh any efficiency benefits.

by the market

for corporate

control

4.2. The evidence Table 8 shows the average percentage changes in premium income and industry-adjusted premium income before and after the initiation of the mutualization process for each cost group. We average the data across firms within a group for years relative to the approval of mutualization and then average for years - 10 to - 1 and years 0 to 9. For firms in the high-cost group (where mutualization implies little change in the effectiveness of the market for corporate control) the data are consistent with the efficiency motivation. These firms show significant increases in both the average percentage change in premium income (4.30% to 8.39%) and the average percentage change in industry-adjusted premium income (1.95% to 5.08%) in the period subsequent to the approval of mutualization. In contrast,

D. Muyers and C. W. Smith, Jr., Mutualization

94


Table 9 Product

cost

mix five years before and after the approval of the mutualization firms within cost groups.

group

(1) Hi@ (6 firms) (6 firms)

Non-participating Participating % Whole-life/endowment Term-life I% Group-life %

(2) Indeterminateb (6 firms) Non-participating Participating (5 firms)

(3) Low’ (7 firms) (6 firms)

% %

%

Whole-life/endowment Term-life % Group-life %

Non-participating Participating % Whole-life/endowment Term-life % Group-life %

%

% %

process,

averaged

across

5 years before

5 years after

Difference

55.55 44.45

53.48 16.52

- 2.07 + 2.07

-0.33 0.33

90.47 8.12 1.42

77.27 12.80 9.93

- 13.20 4.68 8.51

~ 2.05 1.74 1.34

57.38 42.62

53.67 46.33

- 3.71 3.71

- 0.49 0.49

67.28 11.62 21.10

49.60 9.02 41.38

~ 17.68 - 2.60 20.28

- 8.19d -0.69 4.02d

38.81 61.19

37.69 62.31

-1.12 1.12

-0.17 0.17

76.00 9.50 14.50

66.22 12.30 21.43

~ 9.70 2.80 6.93

- 3.07d 2.06 2.03

t-statistic

“High cost to form effective competing coalition because (1) president has blocking power, (2) management coalition has blocking power, or (3) are contractual constraints to effective competing coalitions. bFirms have high ownership concentration in non-management hands. ‘No significant ownership concentration. dSignificant at 0.05 level or better.

firms in the low-cost group (where mutualization implies a reduction in the effective disciplining by the market for corporate control) show a (not significant) decrease in the average percentage change in premium income (9.09% to 7.02%) and a significant decrease in the average percentage change in industry-adjusted premium income (7.53% to 2.66%) subsequent to the initiation of the mutualization process. While the evidence for this group is consistent with some policyholder expropriation, the evidence for the entire sample of firms is consistent with a differential, observable response in the output market depending on the corporate control implications of the transaction. Product mix changes. We also examine the evidence on product mix shifts and lapse ratios averaged within cost groups. Table 9 indicates that for each cost group the distribution of business between non-participating and par-

D. Muyers and C. W. Smith, Jr., Mutualrzation of stock hfe insurance companies

95

ticipating policies was unchanged from five years before approval to five years after approval. The distribution of business among whole-life/endowment, term and group policies does appear to have shifted towards more group and term policies for the high-cost group and the low-cost group. But the shifts appear almost identical for these two cost groups. Thus, even ignoring the industry adjustment in the product-mix data (discussed in section 3.1), it does not appear that shifts in product mix can explain our results. The lapse ratio evidence is equally unrevealing (and we omit it). Lapse ratios and industryadjusted lapse ratios are on average the same in the five years prior to approval and the five years after approval for all three cost groups. Thus the evidence appears generally consistent with the existence of an efficiency motivation for mutualization. It also appears consistent with the hypothesis that the market for corporate control disciplines more effectively when firms are organized as stock companies as compared with mutuals. Moreover, this evidence reinforces our conclusion about the information hypothesis discussed in section 3.2. If an information effect were the sole explanation, we would expect the largest negative effect in the high-cost group where management controls a substantial fraction of the shares. But that is the group where the favorable change in premium income is most pronounced. The data in table 8 allows us to assess another alternative explanation of the premium-income data, that mutuals provide incentives for sales or size maximization. While the premium-income growth rates observed in table 2 are consistent with a joint expropriation and size maximization hypothesis, the more detailed data in table 8 are not. No simple version of this hypothesis would seem capable of explaining the variation in the changes in premiumincome growth rates across the subsamples reported in table 8. Therefore, we conclude that size maximization by mutuals is not fully consistent with the data for this sample of life insurance firms.

5. Conclusions From our examination of changes in premium income, changes in product mix, changes in policy lapse rates, returns to stockholders, and changes in management turnover, we conclude that for this sample of firms changing from a stock to a mutual-ownership structure is on average efficiency-enhancing. Our evidence indicates that growth in premium income does not fall, policy lapse rates do not rise, stockholders receive a premium for their stock, management turnover declines, and there is no significant change in product mix. Therefore, no group of claimholders systematically loses in the sample of firms which choose to go through the mutualization process. This result is consistent with rational voting behavior, since stockholders, policyholders, and managers all have effective vetoes of the plan.

96



Our subdivision of the sample by concentration of ownership prior to mutualization reinforces these conclusions. We examine separately the firms where, prior to mutualization, the shares are diffusely held versus the firms where ownership of the majority of the shares is concentrated in the hands of the firms’ existing managers. For the firms with relatively diffused ownership, there is a greater reduction in the potential disciplining effects of the market for corporate control than in the management-controlled firms. Hence, if mutualization is efficiency-motivated, favorable effects on policyholders should be more pronounced in the management-controlled firms than in the diffusely held firms. Thus, our evidence that there is a favorable change in premium income for management-controlled firms seems strong confirming evidence of the existence of an efficiency motivation. The evidence of reduced industry-adjusted premium-income changes for the diffusely held firms is consistent with either an efficiency motivation where the costs of a less effective market for corporate control outweigh the efficiency benefits (i.e., a miscalculation) or an expropriation motivation for these firms. Our evidence should be contrasted with that of Nicols (1967), Spiller (1972) Frech (1980) and O’Hara (1981). From their tests, they all conclude that mutuals are inefficient. We think that the difference in results occurs because our time-series examination of changes in ownership structure picks up both the additional costs of mutuals associated with less effective control of management as well as the additional benefits associated with more effective control of the fixed-residual claimholder conflict. Their cross-sectional tests cannot easily measure these additional benefits. In providing evidence on the potential efficiency of the mutual organizational form, our analysis of the mutualization process should also be useful in assessing other related transactions. For instance, a merger between stock and mutual insurers with the mutual being the surviving firm achieves similar organizational changes. Thus, the case of Nationwide Corporation reported in the January 1983 Best’s Review is noteworthy. Nationwide Corporation, the parent company of the insurer and affiliated companies completed a merger into First Plaza Corporation, a subsidiary of Nationwide Mutual Insurance Company. Thus, through merger rather than mutualization statutes, stockholders were eliminated.

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Cleveland Company, Company,


of stock life insurance compames

91

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Smith, Clifford W., Jr. and Jerold B. Warner, 1979, On financial contracting: An analysis of bond covenants, Journal of Financial Economics 7, 117-161. Stiller. R.. 1972. Ownershin and nerformance: Stock and mutual life insurance companies, Journal of Risk and Ins&rice 34, 17-25. Stalson, J.O., 1942, Marketing life insurance: Its history in America (Harvard University Press, Cambridge, MA). Temporary National Economic Committee, 1940, Study of legal reserve life insurance companies (U.S. Government Printing Office, Washington, DC). Vermaelen, Theo, 1981, Common stock repurchases and market signalling: An empirical study, Journal of Financial Economics 9, 139-183. Zartman, Lester W., 1907, Control of life insurance companies, Journal of Political Economy 15, 531-541.