Optimal Trading and Asset Pricing with a Large Shareholder

Optimal Trading and Asset Pricing with a Large Shareholder

By
Peter M. DeMarzo, Branko Uroševic
Journal of Political Economy.
2006, Vol. 114, Issue 4, Pages 774-815

We analyze the optimal trading and ownership policy of a large shareholder who must trade off diversification and monitoring incentives. Without commitment, the problem is similar to durable goods monopoly: the share price today depends on expected future trades. We show that the large shareholder ultimately trades to the competitive price-taking allocation, even though it entails inefficient monitoring. With continuous trading, the large shareholder trades immediately to this allocation if moral hazard is weak enough that her private valuation of a share is decreasing in her stake. Otherwise, the large shareholder adjusts her stake gradually. We consider implications for asset pricing, IPO underpricing, and lockup provisions.