Uncertainty, Disagreement, and Allocation of Control in Firms
62 Pages Posted: 22 Nov 2013 Last revised: 16 Feb 2022
Date Written: February 14, 2022
We study the impact of (Knightian) uncertainty on the allocation of control in firms. Uncertainty generates disagreement between insiders and outsiders. Optimal governance depends on both firm characteristics and the composition of the outsider's overall portfolio. Strong governance is desirable when assets in place, relative to the growth opportunity, are sufficiently small or is sufficiently large, suggesting a corporate governance life cycle. Diversified outsiders prefer stronger governance, while outsiders with portfolios heavily invested in similar assets as the firm are more willing to tolerate weak governance. Finally, uncertainty links governance and transparency, whereby firms with weak governance should be opaque.
Keywords: Corporate Governance, Ambiguity Aversion, Disagreement
JEL Classification: G34, D81
Suggested Citation: Suggested Citation