Multiple Blockholders, Price Informativeness, and Firm Value Alex - - PowerPoint PPT Presentation

Multiple Blockholders, Price Informativeness, and Firm Value

Alex Edmans, Wharton Gustavo Manso, MIT Sloan

Notre Dame Finance Seminar

October 12, 2007

Edmans and Manso Multiple Blockholders October 12, 2007 1

Introduction

What is the optimal blockholder structure that maximizes the e¤ectiveness of corporate governance? Traditional view: blockholders govern through intervention (“voice”)

– Few, concentrated stakes are optimal to minimize free-rider problems and maximize intervention incentives – But most …rms have multiple small blockholders (Zwiebel (1995), Barca and Becht (2001), Faccio and Lang (2002), Maury and Pajuste (2005), Holderness (2007))

This paper provides a potential justi…cation for multiple blockholder structures

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Introduction (cont’d)

MBs increase the e¤ectiveness of a second governance mechanism: trading (“exit”)

– Managerial e¤ort improves fundamental value, but manager is paid according to stock price – Trading causes prices to re‡ect fundamental value, rewarding e¤ort ex post

Dynamic consistency issues: once e¤ort has been exerted, blockholders are only concerned with maximizing trading pro…ts

– A single blockholder will strategically limit her order, reducing price informativeness – Multiple blockholders trade competitively, as in a Cournot oligopoly

* Here, co-ordination problems help, by serving as a commitment device to reward the manager ex post

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Related Literature

Zwiebel (1995), Bennedsen and Wolfenzon (2000): control contest motivations for MBs Di¤erences with Edmans (2007):

– Considers both “voice” and “exit”, and the trade-o¤s between them – Fundamental agency problem is shirking, not myopia – Derives multiple blockholders as an optimal structure, and analyzes the determinants of the e¢cient number

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The Model

Manager owns α, I blockholders collectively own β (i.e. β/I each) t = 1: manager exerts e¤ort a, each blockholder exerts e¤ort bi (all at unit cost)

– Firm value: e v = φa log a + φb log ∑i bi + e η – a is private (critical), bi is public (non-critical)

t = 2: trading by blockholders and liquidity investors

– Each blockholder observes e v perfectly and demands xi(e v) – Noise traders demand e ε N(0, σ2

ε )

– Market maker observes order ‡ow e y = ∑i e xi +e ε and sets e p = E[e vje y]

Manager maximizes αe p a Blockholder maximizes individual trading pro…t + value of shares - cost of e¤ort

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The Trading Stage

Proceed by backward induction: take a and bi as given Unique linear equilibrium is symmetric: xi(e v) = γ(e v φa log a φb log ∑i bi) 8i p(e y) = φa log a + φb log ∑i bi + λe y, Each blockholder’s trading pro…ts are

1 p I (I +1)σησε

Price informativeness is negatively related to σ1 Var(e vj˜ p) =

1 I +1ση

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The Action Stage

Optimal actions: a = φaα

• I

I + 1

• bi = φbβ

1 I 2 ∑i bi = φbβ 1 I

• .

∑i bi is decreasing in I

– Blockholders exert positive externalities on the …rm, which they do not consider – “Too little” intervention: standard free-rider problem

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The Action Stage (cont’d)

a is increasing in I

– Blockholders exert negative externalities on each other, which they do not consider – “Too much” trading

* Reduces informed trading pro…ts, hurting blockholders in aggregate * Increases price informativeness

– But …rm value does not depend on informed trading pro…ts, but instead price informativeness

* Co-ordination problems commit to “too much” trading, creating a dynamically consistent reward mechanism for managerial e¤ort

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The Optimal Number of Blockholders

Optimum for …rm value: I = max h 1, φaφb

φb

i I depends on trade-o¤ between e¤ect on blockholder e¤ort (“voice”) and managerial e¤ort (via “exit”)

– φb depends on nature of blockholders’ expertise

* High if forward-looking (“prospective”) information, e.g. venture capital * Low if backward-looking (“retrospective”) information, e.g. rentier capital * High if strong control rights (holding β constant), e.g. foreign blockholders

– φa depends on manager’s scope to improve …rm value

* High in growth industries, low in regulated industries

– Weak governance increases both φa and φb and thus has ambiguous e¤ects

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The Optimal Number of Blockholders (cont’d)

Social optimum considers:

– Cost of managerial e¤ort (reducing I

soc relative to I )

– Cost of blockholder e¤ort (increasing I

soc relative to I )

Private optimum considers:

– β% of increase in …rm value – Cost of blockholder e¤ort (increasing I

priv relative to I )

– Informed trading pro…ts (reducing I

priv relative to I )

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In Progress ...

E¤ect of information asymmetry

– Likely to reduce potency of exit and thus I

E¤ect of liquidity

– Currently, σε is irrelevant, but may become signi…cant if costly information acquisition – Likely to increase potency of exit and thus I

Asymmetric blockholders Further suggestions?

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