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


  • Ernst Maug

    1. Fuqua School of Business, Duke University
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    • The author is with the Fuqua School of Business, Duke University. An earlier version of this paper entitled “Institutional Investors as Monitors: On the Impact of Insider Trading Legislation on Large Shareholder Activism” was presented at Birkbeck College, Duke University, the European University Institute in Florence, HEC Lausanne, INSEAD, the London School of Economics, Katholieke Universiteit de Leuven, Université Catholique de Louvain, the University of Southampton, the University of Vienna, the meetings of the Western Finance Association in Aspen (1995), the Symposium in Financial Markets in Gerzensee (1995), the European Finance Association meetings in Milan (1995), and the CEPR conference on Market Microstructure in Barcelona (1996). I am grateful to the many seminar discussants for helpful comments. I am indebted to an anonymous referee and Ron Anderson, Michael Bradley, Richard Brealey, Judy Chevalier, Deborah DeMott, James Dow, Julian Franks, Denis Gromb, Michel Habib, Steve Huddart, Jack Hughes, Pete Kyle, Anthony Neuberger, David Pyle, Ulf Schiller, René Stulz (the editor), S. Viswanathan, Josef Zechner, and Luigi Zingales for stimulating discussions and advice on this paper. Thanks are also due to Nancy Keeshan, Will Moore, and Cornelia Wels-Maug for a meticulous reading of the manuscript to bring it in to accord with the rules of written English.


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.