The Effect of Speculative Monitoring on Shareholder Activism

April 2016.

This paper investigates how informed trading in financial markets affects the incentive of a large shareholder to monitor a company. The shareholder engages in costly monitoring activities to the extent that she can profitably trade on her private information about these activities. By making stock prices more informative about these activities, informed trading increases the shareholder's incentive to undertake such value-enhancing activities in case she has to liquidate her stake before their effect is publicly observed. This reduces the size of the stake that the shareholder has to acquire to commit to her desired level of monitoring. At the same time, a more informative stock price reduces the value of the shareholder's private information and hence her benefit from monitoring. If acquiring a large stake is excessively costly to the shareholder, the former effect dominates and an increase in informed trading, which reduces market liquidity, can lead to an increase in monitoring efforts. In this case, there is a complementarity between shareholder activism and informed trading, and multiple equilibria with different levels of ownership concentration and monitoring may coexist.

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