Capital Lock-in, Liquidity, and the Separation of Ownership and Control

Abstract

Who should own firm assets, the collection of investors or a distinct legal entity? In a partnership, individual investors own firm assets and retain the right to unilaterally withdraw their capital at will. If, instead, firm assets are owned by a distinct legal entity (the corporation), investors implicitly waive this right, locking capital in the firm. Capital lock-in facilitates long-term investments but carries a risk of inefficient continuation of unprofitable projects. Withdrawal at will can lead to the inefficient liquidation of profitable projects. In this paper I provide a theory of the capital lock-in and the choice of organizational form.

Keywords: liquidity, ownership and control, theory of the firm, legal entity, capital lock-in

JEL Classification: G30, K22