The Scarcity of Effective Monitors and Its Implications For Corporate Takeovers and Ownership Structures

Gary Gorton and Matthias Kahl

University of California at Los Angeles, Anderson Graduate School of Management from Anderson Graduate School of Management, UCLA

Abstract: Agency problems in firms are prevalent because effective corporate monitors are scarce. This paper presents a model that formalizes the scarcity of effective monitors and explores its implications for corporate monitoring mechanisms and ownership structures. We call the most effective monitors - wealthy investors with corporate governance ability – “restructuring specialists”. Their special monitoring ability is a scarce resource in the economy. These restructuring specialists are more effective monitors than coalitions of many small investors run by managers, which face their own agency problems that make them less effective at monitoring. The restructuring specialists have an incentive to acquire blocks for restructuring purposes only in those states of the world in which a restructuring increases firm value the most. This corresponds to a takeover. The restructuring specialists’ investment strategy is an important determinant of corporate ownership structures. Initially dispersed ownership can be optimal only if sufficient liquidity trading allows these special monitors to benefit from state-contingent block acquisitions. The extent of dispersed ownership also depends on the degree of monitoring superiority of the restructuring specialists and the capital available to them, as well as the likelihood that a restructuring may be needed. Firms with initially dispersed ownership and with a financial intermediary as a blockholder can coexist although they are otherwise identical. The model can explain several observations concerning ownership structures and monitoring mechanisms in different developed economies.

Date: 2001-07-07
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