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Corporate Governance Externalities

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Author Info
Acharya, Viral V
Volpin, Paolo

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Abstract

We argue that the choice of corporate governance by a firm affects and is affected by the choice of governance by other firms. Firms with weaker governance give higher payoffs to their management to incentivize them. This forces firms with good governance to also pay their management more than they would otherwise, due to competition in the managerial labour market. This externality reduces the value to firms of investing in corporate governance and produces weaker overall governance in the economy. The effect is stronger the greater the competition for managers and the stronger the managerial bargaining power. While standards can help raise governance towards efficient levels, market-based mechanisms such as (i) the acquisition of large equity stakes by raiders and (ii) the need to raise external capital by firms can help too, and we characterize conditions under which this happens.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6627.

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Date of creation: Jan 2008
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Handle: RePEc:cpr:ceprdp:6627

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Related research
Keywords: corporate governance; executive compensation; externality; governance standards; ownership structure; regulation;

Find related papers by JEL classification:
G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
J63 - Labor and Demographic Economics - - Mobility, Unemployment, and Vacancies - - - Turnover; Vacancies; Layoffs
K22 - Law and Economics - - Regulation and Business Law - - - Corporation and Securities Law
K42 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - Illegal Behavior and the Enforcement of Law
L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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