Trust and Opportunism in Close Corporations

A central problem for closely held corporations is the possibility of op-portunistic behavior by a majority shareholder. Many closely held cor-porations have a 50 percent-plus shareholder and one or more owners of minority interests. The majority shareholder may use its control of the corporate machinery to appropriate wealth from the minority. A growing literature examines how close corporation shareholders (through organizational choices) and the legal system (by providing orga-nizational default settings and adjudicating disputes) can reduce the costs associated with majority opportunism. This paper formalizes the analysis by modeling the interaction between majority and minority shareholders as a noncooperative trust game. In the game, the majority is constrained by the possibility of nonlegal sanctions, including family or social disap-proval and loss of reputation, and, as a result, a rational minority share-holder will sometimes invest despite the potential for exploitation. The strength of those sanctions is assumed to vary over time, and the minor