The Effects of Shareholder Disagreement Under Majority Voting

Abstract

This paper analyzes investment decisions and share trade when the owners of a firm are not unanimous. We use a one-period model with one firm, two owners and incomplete financial markets. The investment decision is assumed to be made by the majority owner. We study the effects shareholder heterogeneity on the amount of investment, the firm value and after-trade ownership stakes. As an extension, a protection of the minority owner from unfavorable investment decisions (an outside option or participation constraint) is introduced. When this constraint binds, it does not only change the investment level, but also decreases the concentration of ownership, consistent with cross-country studies that found that minority shareholder protection and ownership concentration are substitutes. When the model is extended by private benefits of control and a second time period, the identity of the majority owner in the second period is endogenously determined in the model. We observe anti-takeover measures by the initial controlling owner at points close to the transfer of control. As for the ownership dynamics, the initial controlling owner typically accumulates shares over time. The model can be applied to post-privatization firms in developing or transition countries. The assumptions of incomplete financial markets (no external finance, no public stock markets) and private benefits of control are particularly appropriate here. The model rationalizes the observed decrease in worker ownership and the increase in managerial ownership after privatization in several countries.

Keywords: shareholder unanimity, objective of the firm, Fisher Separation Theorem, private benefits of control

JEL Classification: D21, D52, D92, G32, L21