LARGE SHAREHOLDER ACTIVISM, RISK SHARING, AND FINANCIAL MARKET EQUILIBRIUM

We develop a model in which a large investor has access to a costly mo nitoring technology affecting securities' expected payoffs. Allocation s of shares are determined through trading among risk-averse investors . Despite the free-rider problem associated with monitoring, risk-shar ing considerations lead to equilibria in which monitoring takes place. Under certain conditions the equilibrium allocation is Pareto efficie nt and all agents hold the market portfolio of risky assets independen t of the specific monitoring technology. Otherwise distortions in risk sharing may occur, and monitoring activities that reduce the expected payoff on the market portfolio may be undertaken.