The dynamics of the management-shareholder conflict

This article investigates the distribution of equity ownership between entr enched management and dispersed outsiders when management has the ability t o manipulate the cash flows and when it is costly for equity holders to pro ve managerial wrongdoing in court, Management chooses the distribution of e quity ownership so as to maximize private benefits against the risk of pote ntial control challenges. When shareholders are long-term oriented, then ou tside shares trade at a premium over their value to management, and managem ent is inclined to sell off its equity stake to dispersed outsiders. When s hareholders are short-term oriented, then outside shares trade at a discoun t below their value to management, and disciplinary pressure can be substan tially reduced via strategic share purchases. Changes in the cost of capita l drive a wedge between entrenched management's and dispersed outsider's va luation of shares, Management exercises its option to buy (sell) shares whe n the option is in the money: when management values shares more (less) tha n outsiders do.