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The Effect of Diversification on Price Informativeness and Governance

49 Pages Posted: 20 Aug 2014 Last revised: 23 Aug 2017

Alex Edmans

London Business School - Institute of Finance and Accounting; European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Doron Levit

University of Pennsylvania - Finance Department

Devin Reilly

University of Pennsylvania - Department of Economics

Multiple version iconThere are 3 versions of this paper

Date Written: August 21, 2017

Abstract

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

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

Alex Edmans (Contact Author)

London Business School - Institute of Finance and Accounting ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

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

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Doron Levit

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States

Devin Reilly

University of Pennsylvania - Department of Economics ( email )

160 McNeil Building
3718 Locust Walk
Philadelphia, PA 19104
United States

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