Governance Through Trading and Intervention: A Theory of Multiple Blockholders

Governance Through Trading and Intervention: A Theory of Multiple Blockholders

Alex Edmans, Gustavo Manso

Series number :

Serial Number: 
225/2008

Date posted :

November 01 2008

Last revised :

October 24 2018
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Keywords

  • Multiple blockholders • 
  • Corporate governance • 
  • Market efficiency • 
  • exit • 
  • voice • 
  • free-rider problem • 
  • Wall Street Rule • 
  • voting with your feet

Traditional theories argue that governance is strongest under a single large blockholder, as she has large incentives to undertake value-enhancing interventions. However, most firms are held by multiple small blockholders.

This paper shows that, while such a structure generates free-rider problems that hinder intervention, the same co-ordination difficulties strengthen a second governance mechanism: disciplining the manager through trading. Since multiple blockholders cannot co-ordinate to limit their orders and maximize combined trading profits, they trade competitively, impounding more information into prices. This strengthens the threat of disciplinary trading, inducing higher managerial effort. The optimal blockholder structure depends on the relative effectiveness of manager and blockholder effort, the complementarities in their outputs, information asymmetry, liquidity, monitoring costs, and the manager's contract.

 
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Published in

Published in: 
Publication Title: 
Review of Financial Studies
Description: 
Vol. 24, No. 7, pp. 2395-2428, July 2011

Authors

Real name: 
Gustavo Manso