We analyze the determinants of ownership structure in firms when conflicts of interest on risk arise endogenously via different ownership stakes and firm decisions are made through majority voting. A large block is chosen to incentivize monitoring.Because a large blockholder holds a large share of the firm, he is averse to risky investing. This generates a conflict of interest with dispersed shareholders. Mid-size blockholders, voting in favor of middle of the road projects, mitigate the conflict of interest. Depending on monitoring costs, voting institutions and the nature of the industry, three types of ownership structures arise: one large shareholder with a fringe of dispersed owners, multiple large shareholders and fully dispersed shareholders.
IntroductionMuch of the literature on corporate governance has focused on the role of large shareholders in resolving free riding problems that arise when there is dispersed ownership. 1There is, however, a vast empirical literature documenting that ownership structure takes very diverse forms, ranging from one large shareholder, to multiple intermediate sized shareholders and fully dispersed structures. In the US, 67% of public firms has more than one blockholder with a participation larger than 5%, while only 13% are widely held and 20% has only one blockholder (using the database in Dlugosz, Fahlenbrach, Gompers, and Metrick (2006)). In eight out of nine largest stock markets of the European Union the median size of the second largest voting block in large publicly listed companies exceeds five percent (data from the European Corporate Governance Network). 2 In this paper we provide a novel theory why blockholders may emerge. A larger block implies increased voting rights (and hence an increased ability to affect important firm decisions) but a less diversified portfolio. We investigate how potential conflicts of interest between shareholders on the risk profile of a firm affect the ownership structure of a firm when majority voting is the mechanism for aggregating shareholder preferences. We show that depending on model parameters a variety of ownership structures may emerge, including the often observed multiple large blockholders.Several novel empirical predictions are derived. Our theory links firm characteristics (such as investment size, industry characteristics and minority shareholders participation) to its ownership structure. Moreover, the model makes predictions about how a firm's ownership structure affects its choice of project risk.Empirically, the literature on ownership structure and risk is sparse. To the best of our knowledge, the issue of how potential conflicts of interest can affect a firms 1 See e.g. Grossman and Hart (1980), Stiglitz (1985), Shleifer and Vishny (1986), Holmstrom and Tirole (1993), Admati, Pfleiderer, and Zechner (1994), Burkart, Gromb, and Panunzi (1997), Pagano and Röell (1998), Bolton and Von Thadden (1998), Maug (1998)).2 La Porta, Lopez-De-Silanes, and Shleifer (1999) find that 25% of the firms in various coun...
