Relationship Investing: Large Shareholder Monitoring with Managerial Cooperation

44 Pages Posted: 7 Nov 2008

See all articles by N.K. Chidambaran

N.K. Chidambaran

Fordham University - Gabelli School of Business

Kose John

New York University (NYU) - Department of Finance

Date Written: November 1998

Abstract

We characterize conditions under which a large institutional shareholder and the manager of a firm will establish relationship investing, wherein the manager actively cooperates with the institution in the monitoring process, to resolve agency problems. The setting of our model is that of a privately informed manager choosing between a project that has a faster resolution of uncertainty and a project that has a delayed resolution of uncertainty. The agency problem arises because the manager has incentives to focus on the firm's perceived market value, rather than its true long-term value, through his compensation contract and leads to investment distortions. We show that relationship investing solves the agency problem and reduces the free-riding problem associated with large shareholder monitoring. We also show that under some conditions it is optimal for shareholders to make the manager's compensation more distortionary by increasing the manger's incentives to focus on the firm's perceived market value, in order to induce him to cooperate in the monitoring process.

Suggested Citation

Chidambaran, N.K. and John, Kose, Relationship Investing: Large Shareholder Monitoring with Managerial Cooperation (November 1998). NYU Working Paper No. FIN-98-044, Available at SSRN: https://ssrn.com/abstract=1297123

N.K. Chidambaran (Contact Author)

Fordham University - Gabelli School of Business ( email )

United States

Kose John

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0337 (Phone)
212-995-4233 (Fax)

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