THE EFFECT OF A LARGE SHAREHOLDER ON CORPORATE VALUE

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 shareholder 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 toward 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.