The Dynamics of the Management-Shareholder Conflict

Abstract

This paper investigates the distribution of equity ownership between entrenched corporate insiders and dispersed outsiders when management has the ability to divert or manipulate the cash flows and when it is costly for equity holders to verify or prove any managerial wrongdoing for a third party such as a court. Management chooses the distribution of equity ownership so as to maximize private benefits against the risk of potential control challenges. When shareholders are long term oriented, then outside shares trade at a premium over their value to management, and management is inclined to sell of its equity stake to dispersed outsiders. When shareholders are short-term oriented, then outside share trade at a discount below their value to management, and disciplinary pressure can be substantially reduced via strategic share purchases.