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Trust and Opportunism in Close Corporations

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  • Paul G. Mahoney
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    Abstract

    The majority shareholder in a closely held corporation may use its control of the corporate machinery to appropriate wealth from the minority, and it is difficult for the majority to make a binding commitment not to do so. This paper models the interaction between majority and minority shareholders as a trust game in which the majority is constrained by the possibility of non-legal sanctions, including family or social disapproval and loss of reputation. The paper applies the analysis to the longstanding debate over appropriate exit rules for close corporation shareholders. Where the parties are well-informed and rational and judicial valuations are unbiased, giving the minority the unconditional right to e cashed out should reduce majority opportunism without producing opportunistic behavior by the minority. The paper suggests that the apparent failure of close corporation shareholders to bargain for such a right reflects the courts' success in using dissolution and fiduciary duty actions to deter majority misbehavior.

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    File URL: http://www.nber.org/papers/w6819.pdf
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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6819.

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    Date of creation: Nov 1998
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    Publication status: published as Trust and Opportunism in Close Corporations , Paul G. Mahoney. in Concentrated Corporate Ownership , Morck. 2000
    Handle: RePEc:nbr:nberwo:6819

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    1. Geoffrey Brennan & Werner Güth & Hartmut Kliemt, 2003. "Trust in the Shadow of the Courts," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 159(1), pages 16-, March.
    2. Ariel Rubinstein, 2010. "Perfect Equilibrium in a Bargaining Model," Levine's Working Paper Archive 661465000000000387, David K. Levine.
    3. Lucian Arye Bebchuk & Howard F. Chang, 1991. "Bargaining and the Division of Value in Corporate Reorganization," NBER Technical Working Papers 0097, National Bureau of Economic Research, Inc.
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    Cited by:
    1. Joseph A. McCAHERY & Erik P.M. VERMEULEN & HISATAKE Masato & SAITO Jun, 2007. "Traditional and Innovative Approaches to Legal Reform: 'The New Company Law'," Discussion papers 07033, Research Institute of Economy, Trade and Industry (RIETI).

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