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Corporate Governance Externalities

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  • Acharya, Viral V
  • Volpin, Paolo

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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Bibliographic Info

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

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Citations

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Cited by:
  1. Giannetti, Mariassunta, 2007. "Serial CEO Incentives and the Structure of Managerial Contracts," CEPR Discussion Papers 6422, C.E.P.R. Discussion Papers.
  2. Carola Frydman & Dirk Jenter, 2010. "CEO Compensation," CESifo Working Paper Series 3277, CESifo Group Munich.
  3. Pierre Chaigneau & Nicolas Sahuguet, . "The structure of CEO pay: pay-for-luck and stock-options," FMG Discussion Papers dp713, Financial Markets Group.
  4. Roman Inderst & Sebastian Pfeil, 2013. "Securitization and Compensation in Financial Institutions," Review of Finance, European Finance Association, vol. 17(4), pages 1323-1364.
  5. Dittmann, Ingolf & Maug, Ernst & Zhang, Dan, 2011. "Restricting CEO pay," Journal of Corporate Finance, Elsevier, vol. 17(4), pages 1200-1220, September.
  6. Pierre Chaigneau & Nicolas Sahuguet, 2013. "The effect of monitoring on CEO pay practices in a matching equilibrium," LSE Research Online Documents on Economics 55405, London School of Economics and Political Science, LSE Library.
  7. Gallego, Francisco & Larrain, Borja, 2012. "CEO compensation and large shareholders: Evidence from emerging markets," Journal of Comparative Economics, Elsevier, vol. 40(4), pages 621-642.
  8. Pierre Chaigneau & Nicolas Sahuguet, 2014. "Explaining the Association between Monitoring and Controversial CEO Pay Practices: an Optimal Contracting Perspective," Cahiers de recherche 1406, CIRPEE.

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