The equal opportunity rule in transfer of control : a signaling model

The equal opportunity rule is seen as protecting investors in the event of a transfer of control. In order to better analyze the consequence of such a rule, we need to account for the information asymmetry that exists between new controlling shareholders and outside investors with private benefits. Both parties need to design a new implicit contract to share the firm’s ownership, the first one controlling the firm, the other agreeing to stand as minor investors. Using a signaling model, we show that the new controlling shareholder issues signals to outside shareholders to deliver private information on the firm’s future economic return and his private rate of appropriation. We highlight the fact that ownership is a good signal : the higher the share of capital of the controlling shareholder, the better the prospects for future economic return, as perceived by outsiders. Another signaling effect results from the premium embedded in the acquisition price, which also gives information on the future economic prospects of the firm. In a controlling ownership system, the equal opportunity rule modifies the relative behaviors of controlling and outside shareholders. The quality of information deteriorates despite the fact that the discipline may be stronger.