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The effect of a large shareholder on corporate value


Steven Huddart

This article analyzes the value of a corporation as a function of its ownership structure. Shareholders can acquire costly information about the manager's effort to produce output. Concentrating share ownership leads the largest shareholder to (i) acquire more precise signals of effort and (ii) modify the compensation contract. Better monitoring increases output, and hence firm value. However, the (risk-averse) large sharholder bears more idiosyncratic firm risk as his stake in the firm increases. These forces equilibrate at a unique welfare-maximizing ownership structure. Under a strong condition on the purchase or sale of shares by large stockholders, investors have incentives to trade towards the ownership structure that maximizes the social surplus. When all investors are price-takers, only a diffuse ownership structure can arise in a competitive equilibrium.

Management Science Volume 39, Number 11 (November 1993) 1407-1421

Keywords: ownership incentives, risk, agency, monitoring, concentration, trade.

JEL Classification: G32, J30, K22


Steven Huddart
Smeal College of Business, Penn State University, University Park, PA 16802-3603 USA
(814) 863-0048
huddart@psu.edu
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