Most managers enjoy considerable discretion and protection from possible interventions which enables them to look after their own interests. This is often attributed to the dispersion of shareholders and regulations that deter effective outside interventions. This paper presents a model that has empire-building managers who have important effort choices. Because the manager is not the residual claimant of the relevant returns, in order to provide him with the opportunity to share some of the rents he creates. To achieve this, equilibrium organizational form separates control from ownership and tries to contain the manager''s empire-building incentives using performance contracts and the capital structure rather than more direct methods of control. Nevertheless, owners will often be unable to commit to managerial discretion because ownership of the assets gives them the right to decide what use that asset will be put and thus a right to fire the manager. In this case, it will be necessary to choose a disperse ownership structure in order to create free-rider effects among shareholders and thus to commit them to be passive. Thus, the dispersion of ownership, rather than being the cause of the problem, may be a solution to a more serious one. Nevertheless, there will often be benefits to having large shareholders. In this case, the paper shows that an intermediate level of dispersion is the optimum.
