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I. INTRODUCTION AND INQUIRY
This paper examines how two legal regimes governing transfers of control (the "Market Rule" and the "Equal Opportunity Rule") affect the initial public offerings (IPOs) through their influence on private benefits of control. Not only ex post efficiency costs, but also the value-transfer nature of private benefits may thwart efficient IPOs by creating a wedge between discounted stock priced to reflect private benefits of control and the value that the initial owner will really capture. As this paper shows, the two legal regimes generate this wedge through different mechanisms that center, respectively, on competition in the market for control block (for the Market Rule) and asymmetric information about private benefits of control (for the Equal Opportunity Rule).
As economic researchers have found, the controlling shareholder structure, as opposed to diffuse ownership, dominates corporate ownership around the world.1 Even in the United States, where large companies are commonly diffusely held, IPOs generally create an ownership structure in which initial owners retain majority ownership.2 As is well-known, controlling shareholders can extract private benefits of control,3 which influence patterns of ownership structure and external financing by impeding controlled firms from issuing equity to investors and dissuading existing controllers from breaking up their control block.
La Porta, et al. have found that the magnitude of private benefits of control correlates negatively with the incidence of IPOs as well as the size of equity market.4 Given this recent finding, an obvious but important question is: "What features of private benefits of control hamper controllers from taking IPOs, and equity financing in general?" A generic response would be that private benefits of control reduce the value of public shares, which results in a corresponding discount in the stock price, thus discouraging initial owners from selling their stock.5 This answer may not follow, however, given that the discount for private benefits in pricing stock in an IPO merely reflects the private benefits of control that he or she will eventually capture.
Private benefits of control may undermine the value of a company because their extraction (or the possibility of their extraction) generates suboptimal decisions. This efficiency-costs aspect of private benefits of control clearly impedes an initial owner from taking her firm public, given that this owner must...