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The Internal Governance of Firms

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

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.

Suggested Citation

  • Acharya, Viral V & Myers, Stewart C & Rajan, Raghuram G, 2009. "The Internal Governance of Firms," CEPR Discussion Papers 7210, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:7210
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    References listed on IDEAS

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    Cited by:

    1. Bird, Robert C. & Borochin, Paul A. & Knopf, John D., 2015. "The role of the chief legal officer in corporate governance," Journal of Corporate Finance, Elsevier, vol. 34(C), pages 1-22.
    2. Lin, Zhijun & Song, Byron Y. & Tian, Zhimin, 2016. "Does director-level reputation matter? Evidence from bank loan contracting," Journal of Banking & Finance, Elsevier, vol. 70(C), pages 160-176.
    3. Ginglinger, Edith & Megginson, William & Waxin, Timothée, 2011. "Employee ownership, board representation, and corporate financial policies," Journal of Corporate Finance, Elsevier, vol. 17(4), pages 868-887, September.
    4. Jain, Pawan & Jiang, Christine & Mekhaimer, Mohamed, 2016. "Executives' horizon, internal governance and stock market liquidity," Journal of Corporate Finance, Elsevier, vol. 40(C), pages 1-23.
    5. John Buchanan & Dominic Heesang Chai & Simon Deakin, 2013. "Agency Theory in Practice: A Qualitative Study of Hedge Fund Activism in Japan," Working Papers wp448, Centre for Business Research, University of Cambridge.
    6. Ranjan D’Mello & Xinghua Gao & Yonghong Jia, 2017. "Internal control and internal capital allocation: evidence from internal capital markets of multi-segment firms," Review of Accounting Studies, Springer, vol. 22(1), pages 251-287, March.
    7. Edmans, Alex & Goldstein, Itay & Zhu, John, 2011. "Contracting with Synergies," Working Papers 11-65, University of Pennsylvania, Wharton School, Weiss Center.
    8. repec:spr:jbecon:v:88:y:2018:i:2:d:10.1007_s11573-017-0873-5 is not listed on IDEAS
    9. Robin Döttling & Tomislav Ladika & Enrico Perotti, 2016. "The (Self-)Funding of Intangibles," Tinbergen Institute Discussion Papers 16-093/IV, Tinbergen Institute.
    10. Mobbs, Shawn & Raheja, Charu G., 2012. "Internal managerial promotions: Insider incentives and CEO succession," Journal of Corporate Finance, Elsevier, vol. 18(5), pages 1337-1353.
    11. repec:eee:finsta:v:32:y:2017:i:c:p:57-69 is not listed on IDEAS
    12. Massimo G. Colombo & Cristina Rossi-Lamastra, 2013. "The organizational design of high- tech start- ups: state of the art and directions for future research," Chapters,in: Handbook of Economic Organization, chapter 21 Edward Elgar Publishing.
    13. Adair Morse & Wei Wang & Serena Wu, 2016. "Executive Lawyers: Gatekeepers or Strategic Officers?," NBER Working Papers 22597, National Bureau of Economic Research, Inc.
    14. Xavier Hollandts & Nicolas Aubert & Abdelmehdi Abdelhamid & Victor Prieur, 2017. "Beyond Dichotomy: The Curvilinear Impact of Employee Ownership on CEO entrenchment," Working Papers halshs-01495427, HAL.
    15. Bing Guo, 2016. "Manager replacement, employee protest, and corporate control," Economics of Governance, Springer, vol. 17(3), pages 265-294, August.
    16. Vikas Mehrotra & Randall Morck, 2017. "Governance and Stakeholders," NBER Working Papers 23460, National Bureau of Economic Research, Inc.
    17. repec:eee:finana:v:52:y:2017:i:c:p:190-202 is not listed on IDEAS

    More about this item

    Keywords

    Agency theory; Corporate governance; Dividends; Internal organization; Short-termism;

    JEL classification:

    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • 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 - - Personnel Economics - - - Firm Employment Decisions; Promotions

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