We propose that dispersed outside ownership and the resulting managerial discretion come with costs but also with bene ts. Even when tight control by shareholders is ex post ef cient, it constitutes ex ante an expropriation threat that reduces managerial initiative and noncontractible investments. In addition, we show that equity implements state contingent control, a feature usually associated with debt. Finally, we demonstrate that monitoring, and hence ownership concentration, may con ict with performance-based incentive schemes.

We propose a multiperiod model in which competitive arbitrageurs exploit discrepancies between the prices of two identical risky assets traded in segmented markets. Arbitrageurs need to collateralize separately their positions in each asset, and this implies a financial constraint limiting positions as a function of wealth. In our model, arbitrage activity benefits all investors because arbitrageurs supply liquidity to the market. However, arbitrageurs might fail to take a socially optimal level of risk, in the sense that a change in their positions can make all investors better off. We characterize conditions under which arbitrageurs take too much or too little risk.

Posttakeover moral hazard by the acquirer and free-riding by the target shareholders lead the former to acquire as few shares as necessary to gain control. As moral hazard is most severe under such low ownership concentration, inefficiencies arise in successful takeovers. Moreover, share supply is shown to be upward-sloping. Rules promoting ownership concentration limit both agency costs and This project was initiated when all three authors were at the Financial Markets Group at the London School of Economics. We have benefited from comments by Erik Berglöf, Elazar Berkovitch, Patrick Bolton, Arnoud Boot, Gilles Chemla, Jan Ericsson, Abby Innes, Ronen Israel, Kjell Nyborg, Marco Pagano, Ailsa Röell, Jean Tirole, Luigi Zingales, the editor, an anonymous referee, and seminar participants in Barcelona (Institut d'Anàlisi Econò mica), Basel, Boston University, Bologna, Chicago, the European winter meeting of the Econometric Society, the 1995 meeting of the European Summer Symposium in Financial Markets in Gerzensee, Harvard, London School of Economics, Madrid (Centro de Estudios Monetarios y Financieros), Milan (Bocconi), Massachusetts Institute of Technology, Naples, Nordic Symposium on Corporate and Institutional Finance in Sandvika 1995, Pavia, and Stockholm (Stockholm School of Economics and Institute for International Economic Studies). Financial support from Universitá Bocconi (grant Struttura della proprietá azionaria, mercato dei capitali e regolamentazione) and Bankforskningsinstitutet (Burkart) is gratefully acknowledged. All remaining errors are our own. [ Journal of Political Economy, 1998, vol. 106, no. 1] © 1998 by The University of Chicago. All rights reserved. 0022-3808/98/0601-0003$02.50 172 higher takeover premia 173 the occurrence of takeovers. Furthermore, higher takeover premia induced by competition translate into higher ownership concentration and are thus beneficial. Finally, one share-one vote and simple majority are generally not optimal, and socially optimal rules need not emerge through private contracting.