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Contracting About Private Benefits of Control

Ronald J. Gilson

Stanford Law School; Columbia Law School; European Corporate Governance Institute (ECGI)

Alan Schwartz

Yale Law School

July 1, 2013

Columbia Law and Economics Research Paper No. 436
Stanford Law and Economics Olin Research Paper No. 438
Yale Law & Economics Research Paper No. 461
ECGI - Law Working Paper No. 216

The separation of control and ownership – the ability of a small group effectively to control a company though holding a minority of its cash flow rights – is common throughout the world, but also is commonly decried. The control group, it is thought, will use its position to acquire pecuniary private benefits – to take money – and this injures minority shareholders in two ways: there is less money and the controllers are not maximizing firm value. To the contrary, we argue here that pecuniary private benefits may compensate the control group for monitoring managers and otherwise exerting effort to implement projects. There is an optimal level of pecuniary private benefit consumption, we show, that maximizes the control group’s profits, induces constrained efficient controller effort levels and compensates public shareholders for funding the firm’s projects. This result assumes that a controlling group can credibly commit not to consume more than these efficient private benefit shares. When potential entrepreneurs cannot solve this credibility problem, some ex ante efficient firms fail to form because their potential principals cannot raise money. The ability of controllers to commit is increasing in the accuracy of judicial review of controlled transactions. Private contracting, we argue, would materially improve judicial accuracy. Our principal normative recommendation therefore is to demote corporate fiduciary law from mandatory to a set of defaults.

Number of Pages in PDF File: 37

Keywords: corporate control, controlling shareholders, contract law, corporate governance, family firms, private benefits of control

JEL Classification: G30, G 34, G38, L21, K4, K22, L21, K22, 016

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Date posted: November 30, 2012 ; Last revised: July 3, 2013

Suggested Citation

Gilson, Ronald J. and Schwartz, Alan, Contracting About Private Benefits of Control (July 1, 2013). Columbia Law and Economics Research Paper No. 436; Stanford Law and Economics Olin Research Paper No. 438; Yale Law & Economics Research Paper No. 461; ECGI - Law Working Paper No. 216. Available at SSRN: http://ssrn.com/abstract=2182781 or http://dx.doi.org/10.2139/ssrn.2182781

Contact Information

Ronald J. Gilson
Stanford Law School ( email )
559 Nathan Abbott Way
Stanford, CA 94305-8610
United States
650-723-0614 (Phone)
650-725-0253 (Fax)
Columbia Law School ( email )
435 West 116th Street
New York, NY 10025
United States
212-854-1655 (Phone)
212-854-7946 (Fax)
European Corporate Governance Institute (ECGI)
B-1050 Brussels
Alan Schwartz (Contact Author)
Yale Law School ( email )
P.O. Box 208215
New Haven, CT 06520-8215
United States
203-432-4030 (Phone)
203-432-8260 (Fax)
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