Dispersed Initial Ownership and the Efficiency of the Stock Market Under Moral Hazard

The degree to which stock markets can perform theirrole of allocating resources efficiently in the presence of moral hazard isinvestigated. First, an existing framework is extended in order to define stockmarket equilibrium in such a way that allows for a dispersed initial ownershipdistribution in firms. The next section shows that the constrained efficiency of the stock marketbreaks down when entrepreneurs do not have full ownership in their firms beforemarket trading. Although previous research has suggested that this inefficiencycan be resolved through market completion, the argument of this study is that acontract in which an entrepreneur commits to trade his or herfirm onlywith the initial owners can restore the efficiency of the stock market.(SAA)