Document Type

Working Paper

Publication Date



The separation of control and ownership – the ability of a small group effectively to control a company though holding a minority of its cash flow rights – is common throughout the world, but also is commonly decried. The control group, it is thought, will use its position to consume excessive amounts of project returns, and this injures minority shareholders in two ways: there is less money and the controllers are not maximizing firm value. To the contrary, we argue here that there is an optimal share of the firm that compensates the control group for monitoring managers and otherwise exerting effort to implement projects while inducing investors to fund the firm’s projects. This result assumes that a controlling group can credibly commit not to consume more than its efficient share of firm cash flow. When potential entrepreneurs cannot solve this credibility problem, some ex ante efficient firms fail to form because their potential principals cannot raise money at a price that does not reflect inefficient levels of private benefits of control. The ability of controllers to commit is increasing in the accuracy of judicial review of controlled transactions. Private contracting, we argue, would materially improve judicial accuracy. Our principal normative recommendation therefore is to demote corporate fiduciary law from mandatory to a set of defaults. Many developing countries, however, lack an effective legal system, but their public corporations nonetheless commonly have a controlling shareholder and minority shareholders. We explore various non-legal methods by which this shareholder credibly commits to a cap on private benefits of control, although we also show that these methods are less efficient than contracting in a mature legal system would be.


Business Organizations Law | Contracts | Law