This paper addresses the agency problem between controlling shareholders and minority shareholders. This problem is common among public firms in many countries where the legal system does not effectively protect minority shareholders against oppression by controlling shareholders. We show that even without any explicit corporate governance mechanisms protecting minority shareholders, controlling shareholders can implicitly commit not to expropriate them. Stock prices of such companies are significantly higher and firms are more likely go public because of this reputation effect. Moreover, insiders divest shares gradually over time, at a rate that is negatively related to the degree of moral hazard.RECENT EMPIRICAL RESEARCH INDICATES THAT in many countries the relevant corporate finance issue is not the traditional agency problem between management and shareholders, but rather the agency problem between the controlling shareholders and the minority shareholders. This problem may arise in some countries for two reasons:~1! the corporate governance structure of public companies insulates large shareholders-that is, those with a majority of the votes and often with an involvement in the firm's management-from takeover threats or monitoring; 1 and~2! the legal system does not protect minority shareholders because of either poor laws or poor enforcement of laws. 2 Despite the lack of protection for minority shareholders, the average ratio of stock market capitalization held by minorities to gross national product is greater than 40 percent in a sample of 49 countries. 3 This raises the question of why people are willing to be minority shareholders when they know * The Wharton School, University of Pennsylvania. Financial support from CAPES, Brazil, is gratefully acknowledged. I wish to thank Andrei Shleifer and Oliver Hart for their many invaluable suggestions and encouragement in pursuing this work. I am also grateful for helpful comments from the editor and two anonymous referees. I also thank

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a b s t r a c tThe market for public firms issuing private equity, debt, and convertible securities is large. Of the over 13,000 issues we examine, more than half are in the private market. Our results show asymmetric information plays a major role in the choice of security type within public and private markets and in the choice of market in which to issue securities. In the public market, firms' predicted probability of issuing equity declines and issuing debt increases with measures of asymmetric information. There is a weak reversal of this sensitivity in the private market. We also find a large sensitivity of the choice of public versus private markets to asymmetric information, risk and market timing for debt, convertibles, and in particular, equity issues.

We empirically investigate the effects of the adoption of Regulation Fair Disclosure ("Reg FD") by the U.S. Securities and Exchange Commission in October 2000. This rule was intended to stop the practice of "selective disclosure," in which companies give material information only to a few analysts and institutional investors prior to disclosing it publicly. We find that the adoption of Reg FD caused a significant reallocation of information-producing resources, resulting in a welfare loss for small firms, which now face a higher cost of capital. The loss of the "selective disclosure" channel for information flows could not be compensated for via other information transmission channels. This effect was more pronounced for firms communicating complex information and, consistent with the investor recognition hypothesis, for those losing analyst coverage. Moreover, we find no significant relationship of the different responses with litigation risks and agency costs. Our results suggest that Reg FD had unintended consequences and that "information" in financial markets may be more complicated than current finance theory admits.

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