Working Paper: CEPR ID: DP10119
Authors: Alex Edmans; Doron Levit; Devin Reilly
Abstract: This paper studies the corporate governance and asset pricing implications of investors owning blocks in multiple firms. Common wisdom is that multi-firm ownership weakens governance because the blockholder is spread too thinly. We show that this need not be the case. In a single-firm benchmark, the blockholder governs through exit, selling her stake if the firm underperforms. With multiple firms, the blockholder may sell even a value-maximizing firm, to disguise her exit from another underperforming firm as being motivated by a portfolio-wide liquidity shock. This reduces the manager's effort incentives and weakens governance. On the other hand, governance can be stronger, because selling one firm and not the other is a powerful signal of underperformance. Common ownership leads to firms' stock prices being correlated, even if their fundamentals are uncorrelated. We derive empirical predictions for the direction of correlation and for whether governance is stronger or weaker with multiple firms.
Keywords: blockholders; corporate governance; correlation; exit; trading
JEL Codes: D72; D82; D83; G34
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| common ownership (G32) | weaker governance (H11) |
| blockholder engages in balanced exit (G34) | reduces managerial effort incentives (M52) |
| blockholder sells both firms (G34) | signals liquidity shock (E44) |
| blockholder chooses imbalanced exit (D52) | stronger governance (G38) |
| blockholder sells underperforming firm (G34) | strong signal of managerial shirking (D29) |
| agency problem severity (D82) | efficiency of multifirm governance (G34) |
| common ownership (G32) | mitigates agency problem negative effects (G34) |
| blockholder exit strategies (G34) | firm value (G32) |
| common ownership (G32) | stock price correlations (G19) |
| blockholder exit strategy (G34) | direction of stock price correlation (C10) |
| probability of imbalanced exit (C62) | negative correlation (C29) |
| blockholder decision-making process (G34) | implications for managerial behavior (D22) |
| blockholder decision-making process (G34) | implications for stock prices (G17) |