ABSTRACT

LARGE INVESTORS – INSTITUTIONAL INVESTORS such as pension funds, mutual funds, commercial banks, insurance companies, and finance companies, as well as private investors such as initial owners – monitor and control the management of companies on behalf of the other investors.1 However, in recent years, the securitizing of financial assets and a shift away from bank borrowing toward bond and equity financing have grown significantly.2 If this tendency increases the number of shares owned by small and passive investors, it may reduce the incentive for large investors to monitor the performance of the management of a given company. This possibility arises from a free-rider problem: small and passive investors realize part of the benefits of monitoring performed by large investors but they incur none of the costs of the monitoring.This paper investigates how the design and issued amount of security can

be organized so as to best enhance the role of the large investor as a delegated monitor who disciplines the performance of a company’s management.