Traditional theories argue that governance is strongest under a single large blockholder, as she has strong incentives to undertake value-enhancing interventions (engage in “voice”). However, most firms are held by multiple small blockholders. This paper shows that, while such a structure generates free-rider problems that hinder voice, the same co-ordination difficulties strengthen a second governance mechanism: disciplining the manager through trading (engaging in “exit”). Since multiple blockholders cannot co-ordinate to limit their orders and maximize combined pro?fits, they trade competitively, impounding more information into prices. This makes the threat of disciplinary exit more credible, inducing higher managerial effort. The optimal blockholder structure depends on the relative effectiveness of manager and blockholder effort, the complementarities in their outputs, liquidity, monitoring costs, and the manager’s contract.
(Joint paper with Gustavo Manso (Massachusetts Institute of Technology, Sloan School of Management), September 29, 2008