The Balance of Power in Close Corporations

Abstract

We analyze a model of a firm with more than one significant owner (a situation common in close corporations). In particular, we are interested in the optimal ownership structure chosen by the founder of the firm. We show that , by distributing control among several shareholders, the founder forces them to form coalitions to obtain control. This is optimal because a coalition, by grouping the cash flows of its members, internalizes to a larger extent the consequences of its actions, and hence takes more efficient actions than any of its members individually. The model has other implications. We show that having a one-share-one-vote ownership structure can increase efficiency and thereby the value of the firm. In addition, we analyze the optimal number and size of shareholder, or many equal-sized shareholders. We also show that, in firms with several large shareholders, an increase in the number of shareholders reduces efficiency. Finally, we analyze the desirability of restricting trade, and find that it is optimal to do so.

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