The Dark Side of Blockholder Philanthropy

Does the market respond unfavorably to generous CEOs? This paper from Thomas Shohfi “suggests that large philanthropists aren’t very good monitors, and that other investors realize it.”

Who would you rather own a business with, Mahatma Ghandi or Ebenezer Scrooge? Behavioral economics research points to considerable benefits of co-ownership with Gandhi, as counterparties (like suppliers, customers, and potential employees) work harder and offer better contracting terms when dealing with philanthropic principals. Understandably, these contracting parties feel better about not driving the hardest possible bargain, as the proceeds to a firm co-owned by Ghandi go at least partially towards noble causes.Corporate governance research based in agency theory, however, points to Scrooge being a major shareholder also having benefits. That is, small shareholders typically rely on the self-interest of large shareholders to monitor their shared investment. For those small shareholders, having Scrooge as a blockholder may be comforting, as he would likely be a very close monitor of managers (for his own benefit). Research in this mold has found that self-interested blockholder monitoring is particularly effective at discouraging wasteful investments in R&D, M&A, and PP&E. In this line of thinking, where the self-interest of large investors (and their associated monitoring of managers and the firm) comforts small investors, the market could view large investors’ philanthropy as troubling. If this philanthropy signals weakening self-interest on behalf of the newly charitable blockholder in question, smaller investors could worry that, as the monitor they rely on is less interested in wealth, this monitor will subsequently provide less monitoring of their shared investment. Sticking with our original analogy, this is akin to Scrooge taking a big step towards being Ghandi (i.e. Scrooge on Christmas morning). If you relied on Christmas Eve Scrooge’s preferences for wealth to keep an eye on an investment you two shared, this display of Scrooge’s new wealth preferences (giving wealth away à la Christmas morning Scrooge) could certainly have you worried! (citations omitted)

Source: The Dark Side of Blockholder Philanthropy

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