On the Optimal Allocation of Power between Shareholders and Managers
University of Southern California
USC CLEO Research Paper No. C10-12
23rd Australasian Finance and Banking Conference 2010 Paper
USC Law Legal Studies Paper No. 10-13
This paper formally investigates the optimal allocation of power for shareholders recognizing that they may be heterogeneous, and that agency problems exist with managers. In the model I treat shareholders as economic actors who choose decision rules (or the degree of shareholder power) under a veil of ignorance with the goal of maximizing their utility. Managers choose their consumption of private benefits based on the power allocation chosen by shareholders. I demonstrate that heterogeneous shareholders face a trade-off in deciding on the allocation of shareholder power. In the event they are in favor of an investment, shareholders would like to minimize their ability to veto a project. In the event they are against an investment, shareholders would like to maximize their veto power. The optimal voting rule balances these two considerations. Unhappy shareholders who can easily sell their shares do not face this trade-off, in which case they will grant more power to managers. I also demonstrate that in all circumstances shareholders will allocate more power to themselves as a way of controlling managerial agency costs.
Number of Pages in PDF File: 46
Keywords: Shareholders, voting rules, managers, corporate governance
JEL Classification: D72, G34, G38, K22
Date posted: August 6, 2010 ; Last revised: December 9, 2014
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