Governance Through Exit and Voice: A Theory of Multiple Blockholders

Abstract:     
Traditional theories argue that governance is strongest under a single large blockholder, as she has large incentives to undertake value-enhancing interventions (engage in "voice"). However, most firms are held by multiple small blockholders. This paper shows that, while such a structure generates free-rider problems that hinder voice, the same co-ordination difficulties strengthen a second governance mechanism: disciplining the manager through trading (engaging in "exit"). 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 exit, 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.

Keywords: Multiple blockholders, corporate governance, market efficiency, exit, voice, free-rider problem, Wall Street rule, voting with your feet

JEL Classifications: D82, G14, G32

Working Paper Series