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Governance Through Trading and Intervention: A Theory of Multiple Blockholders

31 Pages Posted: 17 Mar 2008 Last revised: 7 Dec 2011

Alex Edmans

London Business School - Institute of Finance and Accounting; European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Gustavo Manso

University of California, Berkeley - Haas School of Business

Date Written: June 29, 2011

Abstract

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

Edmans, Alex and Manso, Gustavo, Governance Through Trading and Intervention: A Theory of Multiple Blockholders (June 29, 2011). Review of Financial Studies, Vol. 24, No. 7, pp. 2395-2428, July 2011; AFA 2009 San Francisco Meetings Paper; ECGI - Finance Working Paper No. 225/2008; EFA 2008 Athens Meetings Paper; U of Penn, Inst for Law & Econ Research Paper No. 08-09. Available at SSRN: https://ssrn.com/abstract=1102730

Alex Edmans (Contact Author)

London Business School - Institute of Finance and Accounting ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Gustavo Manso

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States

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