Control Matters: Law and Economics of Private Benefits of Control

The standard approach to the legal foundations of corporate governance is that corporate law promotes separation of ownership and control by protecting minority shareholders from expropriation. This paper takes a broader perspective on the economic and legal determinants of corporate governance. It shows that legal entitlements to corporate control and their exchange on the market are as important as investor protection. This is based on a third category of ‘idiosyncratic’ private benefits of control, which supplements the more traditional specifications as inefficient consumption of control perquisites (‘distortionary’ private benefits) or outright expropriation of shareholder value (‘diversionary’ private benefits). The framework departs from the standard principal-agent models by assuming that private benefits of control also account for a further value to be appropriated as reward of entrepreneurship in the corporate structure. The quasi-rent nature of this value makes appropriation by corporate controllers a necessary condition for efficiency ex-ante, which implies that control rights are allocated separately from ownership at the going public stage. Under certain assumptions (corresponding to legal restrictions on the behavior of controllers and non-controlling shareholders), a constrained-efficient outcome is derived ex-post as Coasian bargain between the incumbent and the insurgent at the takeover stage. To preserve interdisciplinarity of the discussion, these results are illustrated with a limited degree of formalization. The above findings have important implications for corporate law. When legal institutions effectively constrain expropriation of non-controlling shareholders, they may still distort separation of ownership and control by making ownership structures either more concentrated or more dispersed than it would be efficient. This happens when corporate law fails to provide those who run the company with entitlements to control tenure independently of how much ownership they retain. Likewise, mandatory bid regulations undermine the takeover process by restricting side payments that ultimately support efficient bargaining over the value of corporate control.