A Dynamic Model for Control-ownership Wedge

Description

The efficiency of corporate decisons can be compromised by various frictions. One  important source of financial market frictions involves agency problems. Corporation in  many countries are run by controlling shareholders whose cash flow rights in the firm  are substantially smaller than their control rights (La Porta, Lopez-de-Silanes, and  Shleifer al (1999), Claessens, Djankov, and Lang (2000)). The separation of ownership  and control allows controlling shareholders to pursue private benefits at the cost of other  investors. While there are already extensive empirical studies on the economic and  financial consequences resulting from the divergence between control rights and cash-flow  rights, theoretical treatment of this critical agency friction lags behind.  In this project, we introduce a tractable stochastic equilibrium framework to study  both the direct and indirect costs that are resulting from the divergence between control  rights and cash-flow rights as well as the associated distortions in corporate decisions.  In our setting, the controlling shareholder makes all decisions on behalf of the firm and  steals from the firm, while she is only entitled to a (fixed) fraction of the firm's cash  flow. Our model yields closed-form characterizations of the controlling shareholder's  corporate strategies which suggest that she over-invests, is over-exposed to the market,  and liquidates the firm earlier. Due to the premise of market incompleteness, we need to  solve the value functions for the controlling sharehoder and the firm numerically, by  which we will show that the indirect cost to the firm resulting from the controlling  shareholder's distorted policies substantially dominates the direct cost of stealing.  Specifically, the controlling shareholder effectively own the firm in the limiting case  when firm's liquidity approaches infinity. We will examine different investment technology and outside option for the  controlling shareholder to make a robust argument. Since only transitory shocks are  involved in the baseline model, we will furthermore study an extend version of the model  for changes in the controlling shareholder's corporate policies at the presence of  persistent productivity shocks. Overall, this project will advance our understanding on  the corporate and financial consequences of the control-ownership wedge from a  theoretical perspective.