Governance Through Trading and Intervention: A Theory of Multiple Blockholders
Review of Financial Studies, Vol. 24, No. 7, pp. 2395-2428, July 2011
31 Pages Posted: 17 Mar 2008 Last revised: 7 Dec 2011
Date Written: June 29, 2011
Traditional theories argue that governance is strongest under a single large blockholder, as she has large incentives to undertake value-enhancing interventions. However, most firms are held by multiple small blockholders. This paper shows that, while such a structure generates free-rider problems that hinder intervention, the same co-ordination difficulties strengthen a second governance mechanism: disciplining the manager through trading. 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 trading, 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, informed trading, free-rider problem, Wall Street Rule, voting with your feet
JEL Classification: D82, G14, G32
Suggested Citation: Suggested Citation