Shareholder Diversification and the Value of Control

Individual shareholders often choose to invest a substantial fraction of their wealth in one firm thereby having operational control of the firm through the voting power attached to the shares. In doing so the shareholder reduces the diversification of their personal investment portfolio. A controlling shareholder can also use leverage to increase their voting power, which further increases the risk of their personal portfolio. We argue that the cost of poor diversification reflects the cost of control and we use this in our estimate of the control premium by subtracting the value of shares in the hands of a poorly diversified risk-averse controlling shareholder (Lambert, Larcker and Verrecchia, 1991) from the market value of the shares (Black and Scholes, 1973). This control premium estimate is calculated for a sample of large Swedish firms for which direct estimates of the controlling owners’ wealth are available. We find that the value of control is substantial for individual owners in general, and for the founder in particular. At a Constant Relative Risk Aversion parameter of 2 (3), the average control premium for founders is 12% (25%). The value of control also increases with the size of the controlling voting block.