Diversification and ownership concentration

We use a Tobin-Markowitz mean-variance model where the expected returns for the insiders and outsiders are different to analyze the interactions between portfolio choices and investment financing in an economy with benefits of control for entrepreneurs. The need to diversify the portfolio of the entrepreneur conflicts with the small amount of external finance that can be raised when the possibility to expropriate other providers of funds is ample. This implies that a large fraction of investment must be funded with internal sources, thus limiting both diversification and growth opportunities. Entrepreneurs choose to expropriate outside shareholders even if they compete to attract the savings of the outsiders. Nonetheless, when the diversification opportunities are small it is better to let the entrepreneurs choose independently the level of investor protection than let the entrepreneurs choose the common rules of investor protection.