“Governance through Threats of Intervention and Exit” by Vyacheslav Fos
Charles M. Kahn
University of Illinois at Urbana-Champaign
This paper studies a model in which an activist shareholder has the possibility of disciplining management through the threat of intervention and threat of exit. Intervention is the equilibrium form of governance when the activist has a toehold almost sufficient for exercising voice, when the activist is effective in restoring firm value, and when the temptation for misbehavior by the management is large. Intervention plays a positive disciplinary role only when the activist can punish the manager for misbehavior. A stronger disciplinary role played by the threat of intervention leads to fewer ex-post interventions, and a stronger disciplinary role played by the threat of exit leads to fewer block sales, suggesting that corporate governance is most effective when activists rarely act. When the activist chooses the size of the toehold, he effectively determines the equilibrium form of governance. Forces that lead to the adoption of the most effective governance structure are analyzed.