49 Pages Posted: 20 Aug 2014 Last revised: 23 Aug 2017
Date Written: August 21, 2017
An asset's price informativeness and fundamental value depends on an informed investor's holdings of other, potentially unrelated, assets. If an asset is sold by a concentrated owner, the price decline is low since the sale may be motivated by a liquidity shock. A diversified owner has the choice of which assets to sell upon a shock. Thus, a sale is more revealing of poor asset quality, increasing price informativeness and strengthening governance through both exit (since the price decline upon a sale is greater) and voice (since the payoff from "cutting and running" is lower). The model highlights a channel through which diversification may strengthen governance, in contrast to conventional wisdom that it necessarily weakens it by spreading an investor too thinly.
Keywords: Corporate governance, banks, blockholders, monitoring, intervention, exit, trading, common ownership.
JEL Classification: D72, D82, D83, G34
Suggested Citation: Suggested Citation
Edmans, Alex and Levit, Doron and Reilly, Devin, The Effect of Diversification on Price Informativeness and Governance (August 21, 2017). European Corporate Governance Institute (ECGI) - Finance Working Paper No. 437/2014. Available at SSRN: https://ssrn.com/abstract=2482935
By Roger Gordon