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Trust and Opportunism in Close Corporations

27 Pages Posted: 31 Dec 1998  

Paul G. Mahoney

University of Virginia School of Law

Date Written: November 1998

Abstract

The majority shareholder in a closely held corporation may use its control of the corporate machinery to appropriate wealth from the minority, and it is difficult for the majority to make a binding commitment not to do so. This paper models the interaction between majority and minority shareholders as a trust game in which the majority is constrained by the possibility of non-legal sanctions, including family or social disapproval and loss of reputation. The paper applies the analysis to the longstanding debate over appropriate exit rules for close corporation shareholders. Where the parties are well-informed and rational and judicial valuations are unbiased, giving the minority the unconditional right to e cashed out should reduce majority opportunism without producing opportunistic behavior by the minority. The paper suggests that the apparent failure of close corporation shareholders to bargain for such a right reflects the courts' success in using dissolution and fiduciary duty actions to deter majority misbehavior.

Suggested Citation

Mahoney, Paul G., Trust and Opportunism in Close Corporations (November 1998). NBER Working Paper No. w6819. Available at SSRN: https://ssrn.com/abstract=141122

Paul G. Mahoney (Contact Author)

University of Virginia School of Law ( email )

580 Massie Road
Charlottesville, VA 22903
United States
434-924-7121 (Phone)
434-924-7536 (Fax)

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