Denis Gromb

Large Shareholders, Monitoring, and the Value of the Firm

We propose that dispersed outside ownership and the resulting managerial discretion come with costs but also with benefits. Even when tight control by shareholders is ex post efficient, it constitutes ex ante an expropriation threat that reduces managerial initiative and noncontractible investments. In addition, we show that equity implements state contingent control, a feature usually associated with debt. Finally, we demonstrate that monitoring, and hence ownership concentration, may conflict with performance-based incentive schemes.

Why Higher Takeover Premia Protect Minority Shareholders

Posttakeover moral hazard by the acquirer and free‐riding by the target shareholders lead the former to acquire as few sharcs as necessary to gain control. As moral hazard is most severe under such low ownership concentration, inefficiencies arise in successful takeovers. Moreover, share supply is shown to be upward‐sloping. Rules promoting ownership concentration limit both agency costs and the occurrence of takeovers. Furthermore, higher takeover premia induced by competition translate into higher ownership concen‐tration and are thus beneficial. Finally, one share‐one vote and simple majority are generally not optimal, and socially optimal rules need not emerge through private contracting.

Collusion and the organization of delegated expertise

Abstract We study the optimal design of incentive contracts for experts in different collusion environments, and explore implications for the organization of delegated expertise. We consider a principal relying on experts to gather and report two signals about a projects value. The principal can have a single expert gather both signals or two experts gather one signal each. We show that absent collusion, the multiexpert organization dominates the single expert organization. However, this ranking is reversed when the experts can collude among themselves (horizontal collusion) and with the principal (vertical collusion).

The Dynamics of Financially Constrained Arbitrage

We develop a model of financially constrained arbitrage, and use it to study the dynamics of arbitrage capital, liquidity, and asset prices. Arbitrageurs exploit price discrepancies between assets traded in segmented markets, and in doing so provide liquidity to investors. A collateral constraint limits their positions as a function of capital. We show that the dynamics of arbitrage activity are self-correcting: following a shock that depletes arbitrage capital, profitability increases, and this allows capital to be gradually replenished. Spreads increase more and recover faster for more volatile trades, although arbitrageurs cut their positions in these trades the least. When arbitrage capital is more mobile across markets, liquidity in each market generally becomes less volatile, but the reverse may hold for aggregate liquidity because of mobility-induced contagion.

Financing Capacity Investment Under Demand Uncertainty: An Optimal Contracting Approach

We study the capacity choice problem of a firm whose access to capital is hampered by financial frictions (i.e., moral hazard). The firm optimizes both its capacity investment under demand uncertainty and its sourcing of funds from a competitive investor. Ours is the first study of this problem to adopt an optimal contracting approach: feasible sources of funds are derived endogenously from fundamentals and include standard financial claims (debt, equity, convertible debt, etc.). Thus, in contrast to most of the literature on financing capacity investments, our results are robust to a change of financial contract. We characterize the optimal capacity level under optimal financing. First, we find conditions under which a feasible financial contract exists that leads to the first-best capacity. When no such contract exists, we find that under optimal financing, the choice of capacity sometimes exceeds strictly the efficient level. Furthermore, the firm invests more when its cash is low, and in some cases le...

Drugs, Showrooms and Financial Products: Competition and Regulation When Sellers Provide Expert Advice

We consider a market in which sellers can exert an information-gathering effort to advise buyers about which of two goods best fits their needs. Sellers may steer buyers towards the higher margin good. We show that for sellers to collect and reveal information, profits on both goods must be sufficiently close to each other, i.e., lie within an implementability cone, which competition or regulation may ensure. Instruments to do so vary with the context. Controlling market power while improving the quality of advice is more difficult when sellers have private information on the profitability of the goods.

Financing capacity investment under demand uncertainty

This paper studies the interplay between the operational and financial facets of capacity investment. We consider the capacity choice problem of a firm with limited liquidity and whose access to external capital markets is hampered by moral hazard. The firm must therefore not only calibrate its capacity investment and the corresponding funding needs, but also optimize its sourcing of funds. Importantly, the set of available sources of funds is derived endogenously and includes standard financial claims (debt, equity, etc.). We find that when higher demand realizations are more indicative of high effort, debt financing is optimal for any given capacity level. In this case, the optimal capacity is never below the efficient capacity level but sometimes strictly above that level. Further, the optimal capacity level increases with the moral hazard problems severity and decreases with the firms internal funds. This runs counter to the newsvendor logic and to the common intuition that by raising the cost of external capital and hence the unit capacity cost, financial market frictions should lower the optimal capacity level. We trace the value of increasing capacity beyond the efficient level to a bonus effect and a demand elicitation effect. Both stem from the risk of unmet demand, which is characteristic of capacity decisions under uncertainty.