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Externalities and Corporate Objectives in a World with Diversified Shareholder/Consumers

Published online by Cambridge University Press:  06 April 2009

Robert G. Hansen  and
John R. Lott Jr
Robert G. Hansen
Affiliation:
Tuck School, Dartmouth College, Hanover, NH 03755
John R. Lott Jr
Affiliation:
School of Law, University of Chicago, Chicago, IL 60637
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Abstract

If shareholders own diversified portfolios, and if companies impose externalities on one another, shareholders do not want value maximization to be corporate policy. Instead, shareholders want companies to maximize portfolio values. This occurs when firms internalize between-firm externalities. Any kind of externality, pecuniary or nonpecuniary, vertical or horizontal, suffices. What matters is simply that one company's actions affect another's value. Thus, besides the traditional benefit of risk reduction, portfolio diversification offers additional benefits to shareholders through helping internalize externalities. This paper documents the extent of diversification and cross-ownership of stocks among companies where these externalities are likely to be large and provides a capital market test of how merger offers vary with the extent of cross-ownership.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 31 , Issue 1 , March 1996 , pp. 43 - 68
Copyright
Copyright © School of Business Administration, University of Washington 1996

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