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The Effect of Diversification on Price Informativeness and Governance

49 Pages Posted: 20 Aug 2014 Last revised: 7 Dec 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: December 2017

Abstract

This paper shows that 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). Therefore, diversification may strengthen governance, in contrast to conventional wisdom that it necessarily weakens it by spreading an investor too thinly. Similarly, common ownership may have a positive real effect by improving governance, potentially offsetting any negative effect on consumers.

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 (December 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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