The Internal Governance of Firms

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The Internal Governance of Firms

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Acharya, Viral V.
Myers, Stewart C
Rajan, Raghuram G

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Abstract

We develop a model of internal governance where the self-serving actions of top management are limited by the potential reaction of subordinates. We find that internal governance can mitigate agency problems and ensure firms have substantial value, even without any external governance. Internal governance seems to work best when both top management and subordinates are important to value creation. We then allow for governance provided by external financiers and show that external governance, even if crude and uninformed, can complement internal governance in improving efficiency. Interestingly, this leads us to a theory of investment and dividend policy, where dividends are paid by self-interested CEOs to maintain a balance between internal and external control. Finally, we explore how the internal organization of firms may be structured to enhance the role of internal governance. Our paper could explain why firms with limited external oversight, and firms in countries with poor external governance, can have substantial value.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7210.

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Date of creation: Mar 2009
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Handle: RePEc:cpr:ceprdp:7210

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Find related papers by JEL classification:
D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure
G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy
L21 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Business Objectives of the Firm
M51 - Business Administration and Business Economics; Marketing; Accounting - - Personnel Economics - - - Firm Employment Decisions; Promotions

This paper has been announced in the following NEP Reports:

NEP-ALL-2009-03-14 (All new papers)
NEP-BEC-2009-03-14 (Business Economics)

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This page was last updated on 2009-10-29.

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