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Vol. 84, No. 1
Posted 2002-01-01

Voting Rights, Private Benefits, and Takeovers

by Frank A. Schmid

This article analyzes the effects that institutional design of the firm has on the allocation of control over the firm’s assets. The efficient allocation of control is a necessary condition for the optimal allocation of resources. Dynamic efficiency in resource allocation presupposes that control over firms will change hands when a given allocation becomes suboptimal. Typically, changes in control are brought about through (successful) tender offers or block trades. With regard to takeovers, a firm may have two types of value to consider: First, there is the public value of the firm, which is the market value of the firm’s securities. Second, there may be a private value of the firm. The private value is the benefit an investor enjoys from exercising control over the firm. Private control benefits are most significant for entrepreneurial start-ups, for established family-owned businesses, and for organizations where personal investors also pursue non-pecuniary goals, such as media groups or professional sports organizations. Of the legal arrangements identified in the finance literature, the most significant for wealth-maximization in takeovers are the one share–one vote principle, majority rules, and mandatory tender offers. We analyze the implications of these three institutional arrangements in a simple textbook takeover model. The model helps in understanding the optimal design of a legal environment in which the market for corporate control promotes efficient allocation of capital.

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