exit and voice in corporate governance 4th set of transparencies for tocf
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EXIT AND VOICE IN CORPORATE
GOVERNANCE
4th set of transparencies for ToCF
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I.
Basic idea: Agency problem (adverse selection, moral hazard,...)
want to reduce asymmetry of information by "hiring monitors".
INTRODUCTION
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1 ACTIVE VS PASSIVE MONITORSTwo types of information to be collected
Prospective /value enhancing
Retrospective /value neutral /speculative
INTERVENTION (ex ante) MEASUREMENT
(ex post) boards of directors venture capitalist bank led corporate governance takeovers shareholders activism
speculation (voting with one’s feet)ST debt runs rating agencies IPOs
Retrospective info useful only if enters compensation
(stock option,...)determines refinancing affects pr (keeping job)
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2 INCUMBENTS VS ENTRANTS/ ENTRY INTO CORPORATE GOVERNANCE
"Hired monitors" have their limits:
liquidity needs lack of diversification (Huddart 1993, Admati et al 1994) "wrong choice" collusion.
Example of "free entry": takeovers voicespeculation "exit".
3 CLAIMS HELD BY MONITORS
Claim = incentive scheme for monitor
"insiders"
Monitor
Firm
claims
"uninformed investors"
Debt or equity?
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Depends on what’s being monitored no general answer.
E.g.: moral hazard:
FOSD (“e” determines mean): equity?
SOSD (“e” determine risk): convertible?ST or demandable debt?
collateral (“e” = maintenance) : secured debt.
Fama 1985: junior claimants have greater incentives to monitor
First-come-first-served rule as an incentive for depositors
(Calomiris)
Collateral-taking by banks.
Example of debate:
More likely: want different claimholders to monitor different pieces of information (“advocates”).
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II.
PERFORMANCE MEASUREMENT AND THE VALUE OF SPECULATIVE
INFORMATION
INVESTORS OF PASSAGE
Fixed-investment model
Simplifying assumption: intermediate signal is a sufficient statistic
Effort signal outcome
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Notation :
Assumption: high signal good news about high effort:
A) FREELY AVAILABLE, CONTRACTABLE SIGNAL
• Holmström 1979 sufficient statistic theorem reward
entrepreneur solely on basis of signal (entrepreneur not accountable
for variables (s)he does not control)
pr (signal j | effort i)pr (success | signal j)
• (ICb)
when high signalwhen low signal
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PLEDGEABLE INCOME Incentives require leaving at least
to the entrepreneur
PLEDGEABLE INCOME HAS INCREASED
B) COSTLY, NONCONTRACTABLE SIGNAL
Private cost c of obtaining speculative information
DESIGNATED MONITOR:
Option: can buy s shares at ex ante par value
Call option has no value if monitor does not acquire information. monitors: doesn’t exercise option if low signal
exercises option if high signal.
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Collusion.
Possibility of excessive speculation
Suppose that at cost c (or ), hired monitor can learn final noise. Then gets bigger expected reward:
Problem: pledgeable income goes back to
Notion of “good” and “bad” information acquisition.
ANONYMOUS MONITORING
Stock market: everyone has call (or put) option, integrity of valuation process.
New issue:sale price can no longer be guaranteed to be Grossman-Hart (1980): free rider problem:
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Someone wants to buy price becomeszero gross profit
speculator loses c.
Holmström-Tirole (1993): need liquidity for the equity market.
Liquidity traders:(size s)
(simplified Kyle 1985 model)
All sell
Noone sells
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Outcome
Speculator can make money only if high signal
liquidity traders sell.
contract with entrepreneur
claims issued s claims held
by "liquidity traders"
speculator observes signal
NET ORDERFLOW OBSERVED SPECULATOR LIQUIDITY TRADERS MARKET MAKERS
moral hazard
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Expected gain
Monitoring if
Remarks:
1 Expected returns on shares for liquidity traders smaller than In fact, equal to Empirical implications.
2 Heterogeneity among equityholders important (no liquidity trading
no speculation stock price
uninformative). Why don’t "ST" traders sell their shares to "LT"
traders?
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Beginning of an answer: general equilibrium with LT investors in short supply
LT investors ST investors
Equity premium (here sold under par to attract ST investors).
equity bonds
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III. INVESTOR ACTIVISM
1 BENEFIT OF ACTIVISM: reduces MH (or AS ) and thereby increases pledgeable income.
Modeling
Monitor, by expanding c, eliminates Bad project:
thus: B b
Monitor
Entrepreneur
Two types of bad projects:
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No funding Intermediatedfinance(monitoring)
Direct finance(no monitoring)
A
Assume that monitoring capital is not scarce
Ub=pHR – I - c lower than in the absence of intermediation:
avoids intermediated finance if (s)he can.
Intermediation facilitates financing if
Entrepreneur receives NPV if funded:
Pledgeable income investors' total cost:
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2 COSTS OF MONITORING (besides c)
i. Collusion (Dessi 2005).
ii. Scarcity of monitors (e.g., credit crunch).
iii.Lack of diversification.
iv. Lack of liquidity.
v. May facilitate soft budget constraint.
vi. Overmonitoring– see next (Pagano-Roell 1998),– bad for initiative (Burkart-Gromb-Panunzi 1997).
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Example of overmonitoring
Monitor chooses x
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c(x)
x= pr (monitor finds Bad project)
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Optimum: (1):
Implementation: (2)
monitor should not hold all external shares.
Intuition: 2 externalities
negative on entrepreneur
positive on other investors (0 if holds all external shares)
Since then