The diversification cost of large, concentrated equity stakes. How big is it? Is it justified?

On the decision to go public with dual class stock

“…These latter results suggest that when insiders have a preference for control and considerable wealth invested in their firm, they sell a greater proportion of their cash flow rights relative to their voting rights. Reinforcing this last point, we note that Odegaard (2009) provides evidence from Norwegian firms that there is a substantial cost to insiders from having much of their wealth tied up in a firm.…”

“…What is interesting about this rationale is that it is consistent with Bodnaruk et al's (2008) evidence on the importance of insider diversification for their decision to take their firms public. Furthermore, the importance of diversification for concentrated shareholders is reinforced by Odegaard's (2009) evidence that such shareholders face large wealth losses as a result of their lack of diversification. Whether these actions lead to more aggressive product market behavior as suggested by Choi and Lyandres (2009) is a question for future research.…”

“…Altogether, our evidence suggests that managers take their firms public with dual class stock to retain their uncontestable control while reducing their lack of diversification costs. This conclusion is reinforced by Odegaard's (2009) evidence that the costs to insiders of holding an undiversified portfolio are fairly substantial.…”

Cognitive Biases and Entrepreneurial Under-Diversification

“…Since some studies point out that entrepreneurs demand compensation for their exposure to idiosyncratic risk (Müller, 2011), one possible explanation for this puzzling evidence -i.e., that entrepreneurs 'do not understand' idiosyncratic risk -can be ruled out. 1 Other justifications mostly rely on non-pecuniary benefits such as achieving greater control over their work environment: entrepreneurs obtain substantial rewards from being their own boss and, thus, they are willing to accept a suboptimal risk-return trade-off (Puri and Robinson, 2008;Ødegaard, 2009;Puri and Robinson, 2009;Shefrin, 2011). An alternative explanation is that entrepreneurs may invest in what they think they know better (Vardas and Xepapadeas 2012).…”

The private equity premium puzzle: a behavioural finance approach

“…Indeed, a diversified portfolio of public equity seems to offer a far more attractive risk-return trade-off than that obtained by the typical entrepreneur. The papers that indicate the magnitude of this loss, estimate that if largest owners of private equity were to move from their present portfolio composition in risky assets to a well diversified portfolio, their returns would have increased by about 13% points in annual terms (Heaney and Holmen, 2008;Ødegaard, 2009). Furthermore, results on the private equity premium puzzle do not only hold for entrepreneurial venture, but have also been observed for large family firms (Heaney and Holmen, 2008) and institutional investors investing in private equity (Nielsen, 2011).…”