Large Shareholders as Monitors: Is There a Trade‐Off between Liquidity and Control?

Abstract

This paper analyzes the incentives of large shareholders to monitor public corporations. We investigate the hypothesis that a liquid stock market reduces large shareholders' incentives to monitor because it allows them to sell their stocks more easily. Even though this is true, a liquid market also makes it less costly to hold larger stakes and easier to purchase additional shares. We show that this fact is important if monitoring is costly: market liquidity mitigates the problem that small shareholders free ride on the effort of the large shareholder. We find that liquid stock markets are beneficial because they make corporate governance more effective. IS A LIQUID STOCK MARKET a liability for effective corporate governance? Casual empiricism seems to suggest that a liquid market allows investors to sell out if they receive adverse information about a company, and that, by contrast, a less liquid market forces them to hold on to their investment and to use their votes to influence the company to achieve better returns. A typical example is British Airways' experience, when its senior management came under attack for using unfair competitive practices against one of its smaller rivals, Virgin Atlantic. At the time, the Financial Times noted that Fidelity, the second largest shareholder with a holding of 4.5 percent, "has disposed of almost its entire position, and the Prudential and Standard Life stakes have

Institutional Investors, Corporate Ownership and Corporate Governance: Global Perspectives

“…As such, many of those shareholders that could play an active role in the governance of the corporation instead remain passive. Bhide's view contrasts with the more recent work of Maug (1998), Kahn andWinton (1998), andNoe (1997). Maug argues that the alleged trade-off between liquidity and control does not exist.…”

“…For example, concentrated ownership may reduce market liquidity and thus reduce the ability of the investor to sell their shares (Holmstrom and Tirole, 1993)). This link between monitoring and liquidity has been addressed by a number of studies, including Coffee (1991), Bhide (1994), Maug (1998) and Kahn and Winton (1998). One view is that liquidity and control are antithetical (Coffee (1991) and Bhide (1994)).…”

“…Numerous authors have argued that an important role for large shareholders is to ameliorate agency problems by monitoring or otherwise taking control of the corporation (Shleifer and Vishny (1986), Admati, Pfleiderer, and Zechner (1993), Huddart (1993), Maug (1998) and Noe (1997)). These authors have further argued that, because all shareholders benefit from the actions of a monitoring shareholder without incurring the costs, only large shareholders have sufficient incentives to monitor.…”

Recent developments in German corporate governance

“…The key question is: do blockholders enhance firm value? Value is expected to be created by the increased monitoring of the management by the large blockholders (see, amongst others, Stiglitz (1985), Shleifer and Vishny (1986), Admati et al (1994), Maug (1998), and Kahn and Winton (1998), Renneboog (2000), Franks, Mayer and Renneboog (2001)). There is an extensive literature investigating whether blockholders take corporate governance actions when increased monitoring is necessary (e.g.…”

Managerial risk reduction, incentives and firm value

“…Other theoretical models arrive at the opposite conclusion: liquidity can reduce agency problems. Kahn and Winton (1998) and Maug (1998) show that liquidity reduces the costs that an investor bears in taking a large position to influence the management. Holmstrom and Tirole (1993) show how liquidity can improve incentive contracts by increasing the information content of stock prices.…”