DECISION RIGHTS AND CORPORATE
5th set of transparencies for ToCF
Control right / Authority
between among investors why equityholders in
investors and good times
entrepreneur? debtholders in
REAL bad times?
Private information confers some (how much?) real authority even if
no formal authority.
Why do managers have so much control?
When do they have much control?
Why do minority block shareholders have so much control?
Informational Need for
asymmetry cooperation 2
II. ALLOCATION OF FORMAL AUTHORITY
(Reinterpretation of) Aghion-Bolton 1992
RELINQUISHING CONTROL RIGHTS TO INVESTORS
INCREASES PLEDGEABLE INCOME AND THUS BOOSTS
Example: Fixed investment model
Action non describable, can’t be contracted upon; but can allocate
Suppose action is first-best inefficient:
Investors control: bear none of select profit-enhancing action.
Entrepreneur control: bears all of receives only part of R does
not take painful (profit-enhancing) action.
Either A large and then entrepreneur
Or A not sufficient to attract financing, then (if not too large)
investor control second-best optimal.
Reminiscent of costly collateral pledging!
ONE ARGUMENT IN FAVOR OF "SHAREHOLDER VALUE"
[First-best efficient action two reasons for investor control].
STRENGTH OF BORROWER’ S BALANCE SHEET
no funding entrepreneur
relinquishes retains control
MULTIPLE CONTROL RIGHTS: ST decisions
K control rights
Case #1 (uninteresting)
relinquish only efficient ones.
Case #2 (capital constraint)
(maximizes pledgeable income)
Entrepreneur keeps control rights for which
Principle of relative willingness to pay for control right (pledge less
costly / more redeployable assets first = analogy):
Surrender all control rights for which investor control
is FB optimal, plus some others.
"BORROWS Firm with "BORROWS Firm with
AGAINST strong balance AGAINST weak balance
ASSETS" sheet INCOME" sheet
cash (A) no cash
collateral no collateral
some safe income stream no safe income stream
low private benefit
relinquishes relinquishes most
relatively few control rights
control rights (borrows from
(borrows from venture
market, bank,...) capitalist,...)
B CONTINGENT CONTROL RIGHTS RAISE BORROWING
Combined with signal (e.g., ST profit):
In the absence of action (or with a noncontingent action):
(if signal sufficient statistic).
• With a contingent action: entrepreneur control and reward
if high signal 11
• With a contingent action: investor control and no reward if low
entrepreneur control and reward if high
Pledgeable income under noncontingent investor control:
is smaller if (interesting case)
III. REAL AUTHORITY
Theory often assumes that management has formal right to choose:
dividends / retained earnings
debt / financial structure
next manager when departing CEO
Yet, management has substantial say in these decisions.
Reconciliation: formal and real authority.
Issue with approach of directly assuming management has formal
when real authority?
[ depends on CORPORATE GOVERNANCE!]
n ex ante identical actions, plus status quo (0,0)
only 1 action is "relevant" (others bad)
identity not known ex ante
(a) learns relevant action
(b) proposes the action.
Uninformed investors rubberstamp iff
(say, stronger balance sheet)
more likely to rubberstamp.
Ownership concentration and (active) monitoring:
STRENGTH OF BALANCE SHEET AND
Arm’s lengh relationship (no active monitor)
if investors rubberstamp.
(extra term 0 by definition:
A STRONGER BALANCE SHEET LEADS TO A LESS 18
Suppose cost c > 0: active monitor has same information as
independent of A.
(second reason for why)
relationship lending covaries positively with weakness of
MULTIPLE SECURITIES AND OUTSIDE EQUITY
COSTS WELL UNDERSTOOD: Externalities among investors
(Jensen-Meckling 1976). Debtholders’
MULTIPLE SECURITIES AS A DISCIPLINING DEVICE
FIRST INTERMEDIATE SECOND EFFORT FINAL
EFFORT PROFIT (CHOICE OF p) OUTCOME
LIQUIDATION, R p
DOWNSIZING 0 1-p
POOR INTERMEDIATE PERFORMANCE DEBT CONTROL
FAIR INTERMEDIATE PERFORMANCE EQUITY CONTROL
Dewatripont’s puzzle :
Design of multiple securities in Facilitating renegotiation among
the first place investors
Bondholder trustee and exchange offer
Literature on bankruptcy.