Ambiguity, Disagreement, and Allocation of Control in Firms

53 Pages Posted: 22 Nov 2013 Last revised: 24 Mar 2015

See all articles by David L. Dicks

David L. Dicks

Baylor University - Department of Finance, Insurance & Real Estate

Paolo Fulghieri

University of North Carolina Kenan-Flagler Business School; European Corporate Governance Institute (ECGI)

Multiple version iconThere are 2 versions of this paper

Date Written: January 29, 2015

Abstract

We present a novel source of disagreement grounded in decision theory: ambiguity aversion. We show that ambiguity aversion generates endogenous disagreement between a firm's insider and outside shareholders, creating a new rationale for corporate governance systems. In our paper, optimal corporate governance depends on both firm characteristics and the composition of the outsiders' overall portfolio. A strong governance system is desirable when the value of the firm's assets in place, relative to the growth opportunity, is sufficiently small or is sufficiently large, suggesting a corporate governance life cycle. In addition, more diversified outsiders (such as generalist mutual funds) prefer stronger governance, while outsiders with a portfolio heavily invested in the same asset class as the firm (such as venture capitalists or private equity investors) are more willing to tolerate a weak governance system, where the portfolio companies' insiders have more leeway in determining corporate policies. Finally, we find that ambiguity aversion introduces a direct link between the strength of the corporate governance system and firm transparency, whereby firms with weaker governance should also optimally be more opaque.

Keywords: Corporate Governance, Ambiguity Aversion, Uncertainty Aversion, Disagreement

JEL Classification: G34, D81

Suggested Citation

Dicks, David L. and Fulghieri, Paolo, Ambiguity, Disagreement, and Allocation of Control in Firms (January 29, 2015). ECGI - Finance Working Paper No. 396/2013 ; UNC Kenan-Flagler Research Paper No. 2357599. Available at SSRN: https://ssrn.com/abstract=2357599 or http://dx.doi.org/10.2139/ssrn.2357599

David L. Dicks (Contact Author)

Baylor University - Department of Finance, Insurance & Real Estate ( email )

P.O. Box 98004
Waco, TX 76798-8004
United States

Paolo Fulghieri

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

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