On the Optimal Allocation of Power between Shareholders and Managers

46 Pages Posted: 6 Aug 2010 Last revised: 9 Dec 2014

Nina Walton

University of Southern California

Date Written: February 2011

Abstract

This paper formally investigates the optimal allocation of power for shareholders recognizing that they may be heterogeneous, and that agency problems exist with managers. In the model I treat shareholders as economic actors who choose decision rules (or the degree of shareholder power) under a veil of ignorance with the goal of maximizing their utility. Managers choose their consumption of private benefits based on the power allocation chosen by shareholders. I demonstrate that heterogeneous shareholders face a trade-off in deciding on the allocation of shareholder power. In the event they are in favor of an investment, shareholders would like to minimize their ability to veto a project. In the event they are against an investment, shareholders would like to maximize their veto power. The optimal voting rule balances these two considerations. Unhappy shareholders who can easily sell their shares do not face this trade-off, in which case they will grant more power to managers. I also demonstrate that in all circumstances shareholders will allocate more power to themselves as a way of controlling managerial agency costs.

Keywords: Shareholders, voting rules, managers, corporate governance

JEL Classification: D72, G34, G38, K22

Suggested Citation

Walton, Nina, On the Optimal Allocation of Power between Shareholders and Managers (February 2011). USC CLEO Research Paper No. C10-12; USC Law Legal Studies Paper No. 10-13; 23rd Australasian Finance and Banking Conference 2010 Paper. Available at SSRN: https://ssrn.com/abstract=1654165 or http://dx.doi.org/10.2139/ssrn.1654165

Nina Walton (Contact Author)

University of Southern California ( email )

699 Exposition Boulevard
Los Angeles, CA 90089
United States

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