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The Internal Governance of Firms

Listed author(s):
  • VIRAL V. ACHARYA
  • STEWART C. MYERS
  • RAGHURAM G. RAJAN

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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Article provided by American Finance Association in its journal Journal of Finance.

Volume (Year): 66 (2011)
Issue (Month): 3 (06)
Pages: 689-720

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Handle: RePEc:bla:jfinan:v:66:y:2011:i:3:p:689-720
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  1. Andrei Shleifer & Robert W. Vishny, 1995. "A Survey of Corporate Governance," Harvard Institute of Economic Research Working Papers 1741, Harvard - Institute of Economic Research.
  2. Fama, Eugene F & Jensen, Michael C, 1983. "Agency Problems and Residual Claims," Journal of Law and Economics, University of Chicago Press, vol. 26(2), pages 327-349, June.
  3. Jensen, Michael C, 1993. " The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems," Journal of Finance, American Finance Association, vol. 48(3), pages 831-880, July.
  4. Randall Morck & Andrei Shleifer & Robert W. Vishny, 1989. "Do Managerial Objectives Drive Bad Acquisitions?," NBER Working Papers 3000, National Bureau of Economic Research, Inc.
  5. Lambrecht, Bart M. & Myers, Stewart C., 2008. "Debt and managerial rents in a real-options model of the firm," Journal of Financial Economics, Elsevier, vol. 89(2), pages 209-231, August.
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  8. Hellmann, Thomas F. & Puri, Manju, 2000. "Venture Capital and the Professionalization of Start-up Firms: Empirical Evidence," Research Papers 1661, Stanford University, Graduate School of Business.
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  12. Dyck, Alexander & Morse, Adair & Zingales, Luigi, 2007. "Who Blows the Whistle on Corporate Fraud?," CEPR Discussion Papers 6126, C.E.P.R. Discussion Papers.
  13. Andrew Atkeson & Patrick J. Kehoe, 2005. "Modeling and Measuring Organization Capital," Journal of Political Economy, University of Chicago Press, vol. 113(5), pages 1026-1053, October.
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  19. Timothy Guinnane & Ron Harris & Naomi R. Lamoreaux & Jean-Laurent Rosenthal, 2007. "Ownership and Control in the Entrepreneurial Firm: An International History of Private Limited Companies," Working Papers 959, Economic Growth Center, Yale University.
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  22. David Thesmar, 2009. "Optimal dissent and risk Management within organizations," Post-Print hal-00495931, HAL.
  23. Fluck, Zsuzsanna, 1998. "Optimal Financial Contracting: Debt versus Outside Equity," Review of Financial Studies, Society for Financial Studies, vol. 11(2), pages 383-418.
  24. Hirota, Shinichi & Kawamura, Kohei, 2007. "Managerial control inside the firm," Journal of the Japanese and International Economies, Elsevier, vol. 21(3), pages 324-335, September.
  25. Raghuram G. Rajan & Luigi Zingales, 2000. "The Firm as a Dedicated Hierarchy: A Theory of the Origin and Growth of Firms," NBER Working Papers 7546, National Bureau of Economic Research, Inc.
  26. Stijn Van Nieuwerburgh & Chad Syverson & Hanno Lustig, 2008. "IT, Corporate Payouts, and the Growing Inequality in Managerial Compensation," 2008 Meeting Papers 265, Society for Economic Dynamics.
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  28. Shleifer, Andrei & Vishny, Robert W., 1989. "Management entrenchment : The case of manager-specific investments," Journal of Financial Economics, Elsevier, vol. 25(1), pages 123-139, November.
  29. Steven N. Kaplan & Luigi Zingales, 1997. "Do Investment-Cash Flow Sensitivities Provide Useful Measures of Financing Constraints?," The Quarterly Journal of Economics, Oxford University Press, vol. 112(1), pages 169-215.
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