Managerial Incentives, Financial Constraints and Ownership Concentration

44 Pages Posted: 13 May 2011

Date Written: March 15, 2011


This work investigates the role of equity ownership for the purpose of committing the management to the pursuit of shareholder value in the presence of separation between ownership and control. By rooting the conflicts of interests between managers and shareholders upon the control of internal funds, a simple model allows to analyse the link between profit uncertainty, growth options and decisional powers. Implications are derived for the optimal degree of equity concentration, the effect of firm fundamentals on the allocation of income and control rights, and the pay for luck phenomenon. First, optimal equity ownership is positively related to the short-term performance of the firm and negatively related to both its growth options and riskiness of cash flows. Second, optimal equity ownership is negatively related to the probability of the firm being financially constrained, in the sense that the level of desired investment exceeds internally available resources. It is also shown that straight debt alone does not implement the second best, in absence of a large shareholder. Finally, an interesting result shows that, in presence of financial constraints, pay for luck is associated in equilibrium to a lower optimal degree of ownership concentration: pay for luck and looser governance, as implemented by the internal discipliner of equity concentration, emerge as the equilibrium result of a constrained incentive problem.

Keywords: capital structure, payout policies, corporate governance, corporate control

JEL Classification: G32, G35

Suggested Citation

Protopapa, Marco, Managerial Incentives, Financial Constraints and Ownership Concentration (March 15, 2011). Bank of Italy Temi di Discussione (Working Paper) No. 798, Available at SSRN: or

Marco Protopapa (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314

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