Managerial Value Diversion and Shareholder Wealth

27 Pages Posted: 30 Jun 1998 Last revised: 29 Apr 2009

Lucian A. Bebchuk

Harvard Law School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR) and European Corporate Governance Institute (ECGI)

Christine Jolls

Yale Law School; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: February 1996

Abstract

The agents to whom shareholders delegate the management of corporate affairs may transfer value from shareholders to themselves through a variety of mechanisms, such as self-dealing, insider trading, and taking of corporate opportunities. A common view in the law and economics literature is that such value diversion does not ultimately produce a reduction in shareholder wealth, since value diversion simply substitutes for alternative forms of compensation that would otherwise be paid to managers. We question this view within its own analytical framework by studying, in a principal-agent model, the effects of allowing value diversion on managerial compensation and effort. We suggest that the standard law and economics view of value diversion overlooks a significant cost of such behavior. Many common modes of compensation can provide managers with incentives to enhance shareholder value; replacing such compensation would reduce these incentives. As a result, even if the consequences of a rule permitting value diversion can be fully taken into account in setting managerial compensation, such a rule might still produce a reduction in shareholder wealth--and would not do so only if value diversion would have some countervailing positive effects (a possibility which our model considers) that are sufficiently significant in size.

JEL Classification: K22, G34, G38

Suggested Citation

Bebchuk, Lucian A. and Jolls, Christine, Managerial Value Diversion and Shareholder Wealth (February 1996). The Journal of Law, Economics, and Organization, Vol. 15, No. 2, pp.487-502, 1999; Harvard Law and Economics Discussion Paper No. 179, February 1996. Available at SSRN: https://ssrn.com/abstract=10049 or http://dx.doi.org/10.2139/ssrn.10049

Lucian A. Bebchuk (Contact Author)

Harvard Law School ( email )

Cambridge, MA 02138
United States
617-495-3138 (Phone)
617-812-0554 (Fax)

HOME PAGE: http://www.law.harvard.edu/faculty/bebchuk/

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) and European Corporate Governance Institute (ECGI)

Christine Jolls

Yale Law School ( email )

127 Wall Street
New Haven, CT 06520
United States
203.432.1958 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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