Capital Lock-in, Liquidity, the Separation of Ownership and Control
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Abstract:
Who should own firm assets, the collection of investors or a distinct legal entity? In a partnership, individual investors own firm assets and retain the right to unilaterally withdraw their capital at will. If, instead, firm assets are owned by a distinct legal entity (the corporation), investors implicitly waive this right, locking capital in the firm. Capital lock-in facilitates long-term investments but carries a risk of inefficient continuation of unprofitable projects. In contrast, withdrawal at will can lead to the inefficient liquidation of profitable projects. In this paper I provide a theory of capital lock-in and the choice of organizational form.