Deconstructing Equity: Public Ownership, Agency Costs, and Complete Capital Markets

Gilson, Ronald J.; Whitehead, Charles K.

The traditional law and finance focus on agency costs presumes, without acknowledgement, that the premise that diversified public shareholders are the cheapest risk-bearers is immutable. In this Essay, we raise the possibility that changes in the capital markets have called this premise into question, drawn into sharp relief by the recent private equity buying wave in which the size and range of public companies being taken private expanded significantly. In brief, we argue that private owners, in increasingly complete markets, can transfer risk in discrete slices to counterparties who, in turn, can manage or otherwise diversify away those risks they choose to forego, arguably becoming a lower cost substitute for traditional risk capital.

If diversified shareholders are no longer the cheapest risk-bearers, then the associated agency costs may now be voluntary; and, if risk management can substitute for risk capital, without requiring a transfer of ownership, then why go public at all? Do more complete capital markets herald (once again) the eclipse of the public corporation? We offer some preliminary responses, suggesting that the line between public and private firms may begin to blur as the traditional balance between agency costs and the benefits of public ownership shifts towards a new equilibrium. For some, the benefits of public ownership may continue to outweigh the associated agency costs. For others, changes in risk transfer may implicate how a firm is (or should be) governed. The Essay then ends with a final question: If the opportunity to invest in common stock recedes, by what means will former investors in public equity be able to invest capital?


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May 30, 2016