We propose that an active takeover market provides incentives by offering acquisition opportunities to successful managers. This allows firms to reduce performance-based compensation and can rationalize loss-making acquisitions. When choosing its acquisition policy and the quality of its board, each firm ignores the adverse effect on other firms’ acquisition opportunities and takeover threat. As a result, the takeover market is not sufficiently liquid and too few takeovers occur. Furthermore, liquidity in the takeover and managerial labor markets are inversely related. When poaching managers becomes more profitable, firms invest more in board quality which in turn reduces the incidence of takeovers.

This paper analyzes how outsiders, such as bidders or activist investors, overcome the lack of coordination and information among dispersed shareholders. We identify the two basic means to achieve this goal. First, the outsider must relinquish private benefits in a manner that is informative about security benefits. We show under which conditions this is feasible and which acquisition strategies used in practice meet these conditions. Second, the outsider can alternatively use derivatives to drive a wedge between her voting power and her economic interest in the firm. Such unbundling of ownership and control, while typically considered a source of corporate governance problems, is an efficient response to the frictions dispersed ownership causes for control contestability. We also show that unbundling comes with costs and benefits for the bidder's incentives to improve firm value.