Large Shareholders as Monitors: Is There a Trade‐Off between Liquidity and Control?

TLDR

The study examines whether a liquid stock market reduces large shareholders’ incentives to monitor public corporations by enabling easier stock sales. The authors analyze the relationship between market liquidity and monitoring incentives, positing that higher liquidity facilitates easier divestment. The results show that while liquidity reduces monitoring incentives, it also lowers the cost of holding large stakes, enabling large shareholders to counteract free‑riding and ultimately improving corporate governance.

Abstract

This paper analyzes the incentives of large shareholders to monitor public corporations. We investigate the hypothesis that a liquid stock market reduces large shareholders' incentives to monitor because it allows them to sell their stocks more easily. Even though this is true, a liquid market also makes it less costly to hold larger stakes and easier to purchase additional shares. We show that this fact is important if monitoring is costly: market liquidity mitigates the problem that small shareholders free ride on the effort of the large shareholder. We find that liquid stock markets are beneficial because they make corporate governance more effective.