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E-MailPaul Voss is Assistant Professor of Economics and Business at Central European University; and Marius Kulms is an Actuary at Continentale Versicherung. This post is based on their recent paper, forthcoming in the American Economic Review.
Our paper Separating Ownership and Information, forthcoming in the American Economic Review, provides a new perspective on the separation of ownership and control—the fundamental problem in corporate governance according to classical theories (Berle and Means 1932; Jensen and Meckling 1976). We show that the separation of ownership and control is necessary for efficient trade in the market for corporate control. Our results highlight the importance of communication between inside and outside shareholders and call mandatory disclosure requirements during takeovers into question.
We develop a model of the market for corporate control with two-sided asymmetric information. We build on the basic idea that insiders obtain private information by virtue of exercising control. Hence, the separation of ownership and control naturally leads to a separation of ownership and information. In the model, ownership and control are separated in that the insider (e.g., incumbent management) controls the firm but only has a minority stake in the outstanding shares. The majority of ownership rights reside with outside shareholders. By exercising control, the insider has private information regarding the target’s stand-alone value vis-à-vis the uninformed, outside shareholders. A potential bidder, who privately knows the value of the target under her management, can obtain control via a tender offer for the majority of shares. The insider can respond by a strategic (cheap talk) recommendation to the outside shareholders, who ultimately decide on the success of the takeover by their tendering decisions.
If ownership and control are unified—that is, if the insider is the sole owner—the efficient allocation of control rights is not feasible. This is because the insider needs to sell part of her shares to induce a successful takeover. To generate profits, the outside bidder will post a tender offer below the expected post-takeover security benefits. As a result, on the shares that need to be tendered for a successful takeover, the insider needs to share the post-takeover security benefits with the outside bidder. By contrast, the insider enjoys all the security benefits she creates when keeping control. This asymmetry endogenously biases the insider against the takeover—even if she does not derive any private benefits of control. Given this fundamental asymmetry, not all value-increasing takeovers can be realized.
If ownership and control are separated, the efficient allocation of control rights can be achieved in equilibrium. Because outside shareholders hold the majority of shares, the informed insider can retain her minority stake while relinquishing control to the bidder. In the efficient equilibrium, the insider does not tender any shares but limits herself to advising the outside shareholders on their tendering decisions. We find that the insider’s recommendation fulfills a dual role. It not only provides part of the insider’s private information but also incentivizes the bidder to fully reveal her private information via the tender offer. Conversely, without communication between shareholders, the bidder never reveals her private information in equilibrium, making efficient trade infeasible.
In the efficient equilibrium, the insider’s recommendation only informs outside shareholders about whether the target’s stand-alone value is above or below the post-takeover security benefits. By keeping shareholders (partially) in the dark, the insider can pool two types of cases in her recommendation: those in which outside shareholders would prefer to tender and those in which outside shareholders would be better off not tendering if they had full information. Thus, the fact that outside shareholders only receive coarse information from the insider is necessary for efficiency. In practice, because legally prescribed fairness opinions and mandatory disclosure requirements can undermine the coarseness of information, they can prevent efficient trade in the market for corporate control. Hence, our model calls such regulations into question.
Nevertheless, our model does not argue for more insider information in general. If insider information could be dispensed with altogether—that is, if the insider had no private information at the outset—efficient trade would be feasible. However, in practice, inside information is pervasive. Given the prevalence of inside information, we show that mandatory disclosure after shareholders are approached with a tender offer can undermine the efficiency of the market for corporate control.
The complete paper is available for download here.
