The Effect of Diversification on Price Informativeness and Governance
49 Pages Posted: 20 Aug 2014 Last revised: 7 Dec 2017
Date Written: December 2017
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: Suggested Citation