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Abstract:
The U.S. corporate governance system has recently been heavily criticized, largely as a result of failures at Enron, WorldCom, Tyco and some other prominent companies. Those failures and criticisms, in turn, have served as catalysts for legislative change (Sarbanes-Oxley Act of 2002) and regulatory change (new governance guidelines from the NYSE and NASDAQ). In this paper, we consider two questions. First, is it clear that the U.S. system has performed that poorly; is it really that bad? Second, will the changes lead to an improved U.S. corporate governance system? We first note that the broad evidence is not consistent with a failed U.S. system. The U.S. economy and stock market have performed well both on an absolute basis and relative to other countries over the past two decades. And the U.S. stock market has continued to outperform other broad indices since the scandals broke. Our interpretation of the evidence is that while parts of the U.S. corporate governance system failed under the exceptional strain of the 1990s, the overall system, which includes oversight by the public and the government, reacted quickly to address the problems. We then consider the effects that the legislative, regulatory, and market responses are likely to have in the near future. Our assessment is that they are likely to make a good system better, though there is a danger of overreacting to extreme events.

U.S. corporate governance system, shareholder value, executive compensation, boards, Sarbanes-Oxley act, comparative corporate governance

Abstract:
The U.S. corporate governance system has recently been heavily criticized, largely as a result of failures at Enron, WorldCom, Tyco and some other prominent companies. Those failures and criticisms, in turn, have served as catalysts for legislative change (Sarbanes-Oxley Act of 2002) and regulatory change (new governance guidelines from the NYSE and NASDAQ). In this paper, we consider two questions. First, is it clear that the U.S. system has performed that poorly; is it really that bad? Second, will the changes lead to an improved U.S. corporate governance system? We first note that the broad evidence is not consistent with a failed U.S. system. The U.S. economy and stock market have performed well both on an absolute basis and relative to other countries over the past two decades. And the U.S. stock market has continued to outperform other broad indices since the scandals broke. Our interpretation of the evidence is that while parts of the U.S. corporate governance system failed under the exceptional strain of the 1990s, the overall system, which includes oversight by the public and the government, reacted quickly to address the problems. We then consider the effects that the legislative, regulatory, and market responses are likely to have in the near future. Our assessment is that they are likely to make a good system better, though there is a danger of overreacting to extreme events.

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Abstract:
This paper describes and considers explanations for changes in corporate governance and merger activity in the United States since 1980. Corporate governance in the 1980s was dominated by intense merger activity distinguished by the prevalence of leveraged buyouts (LBOs) and hostility. After a brief decline in the early 1990s, substantial merger activity resumed in the second half of the decade, while LBOs and hostility did not. Instead, internal corporate governance mechanisms appear to have played a larger role in the 1990s. We conclude by considering whether these changes and the movement toward shareholder value are likely to be permanent.

Abstract:
This paper describes and considers explanations for changes in corporate governance and merger activity in the United States since 1980. Corporate governance in the 1980s was dominated by intense merger activity distinguished by the prevalence of leveraged buyouts (LBOs) and hostility. After a brief decline in the early 1990s, substantial merger activity resumed in the second half of the decade, while LBOs and hostility did not. Instead, internal corporate governance mechanisms appear to have played a larger role in the 1990s. We conclude by considering whether these changes and the movement toward shareholder value are likely to be permanent.

Corporate Governance; Stock Options; Mergers and Acquisitions

Abstract:
This article explores the economic role of the firm in a market economy. The analysis begins with a discussion and critique of the property rights approach to the theory of the firm as exposited in the recent work by Hart and Moore ('Property Rights and the Nature of the Firm'). It is argued that the Hart-Moore model, taken literally, can only explain why individuals own assets, but not why firms own assets. In particular, the logic of the model suggests that each asset should be free standing in order to provide maximal flexibility for the design of individual incentives. These implications run counter to fact. One of the key features of the modern firm is that it owns essentially all the productive assets that it employs. Employees rarely own any assets; they only contribute human capital. Why is the ownership of assets clustered in firms? This article outlines an answer based on the notion that control over physical assets gives control over contracting rights to those assets. Metaphorically, the firm is viewed as a miniature economy, an 'island' economy, in which asset ownership conveys the CEO the power to define the 'rules of the game', that is, the ability to restructure the incentives of those that accept to do business on (or with) the island. The desire to regulate trade in this fashion stems from contractual externalities characteristic of imperfect information environments. The inability to regulate all trade through a single firm stems from the value of exit rights as an incentive instrument and a tool to discipline the abuse of power.

Abstract:
The paper explores the economic role of the firm in a market economy. The analysis begins with a discussion and critique of the property rights approach to the theory of the firm as exposited in the recent work by Hart and Moore ("Property Rights and the Nature of the Firm"). It is argued that the Hart-Moore model, taken literally, can only explain why individuals own assets, but not why firms own assets. In particular, the logic of the model suggests that each asset should be free standing in order to provide maximal flexibility for the design of individual incentives. These implications run counter to fact. One of the key features of the modern firm is that it owns essentially all the productive assets that it employs. Employees rarely own any assets; they only contribute human capital.

Why is the ownership of assets clustered in firms? The paper outlines an answer based on the notion that control over physical assets gives control over contracting rights to those assets. Metaphorically, the firm is viewed as a miniature economy, an "island" economy, in which asset ownership conveys the CEO the power to define the "rules of the game", that is, the ability to restructure the incentives of those that accept to do business on (or with) the island. The desire to regulate trade in this fashion stems from contractual externalities characteristic of imperfect information environments. The inability to regulate all trade through a single firm stems from the value of exit rights as an incentive instrument and a tool to discipline the abuse of power.

Abstract:
The existing literature on firms, based on incomplete contracts and property rights, emphasizes that the ownership of assets - and thereby firm boundaries - is determined in such a way as to encourage relationship-specific investments by the appropriate parties. It is generally accepted that this approach applies to owner-managed firms better than large companies. In this paper we attempt to broaden the scope of the property rights approach by developing a simpler model with three key ingredients: (a) decisions are non-contractible, but transferable through ownership, (b) managers (and possibly workers) enjoy private benefits that are non-transferable, and (c) owners can divert a firm's profit. With these assumptions, firm boundaries matter. Nonintegrated firms fail to account for the external effects that their decisions have on other firms. An integrated firm can internalize such externalities, but it does not put enough weight on the private benefits of managers and workers. We explore this trade-off first in a basic model that focuses on the difficulties companies face in cooperating through the market if benefits are unevenly distributed; therefore they may sometimes end up merging. We then extend the analysis to study industrial structure in a model with intermediate production. This analysis sheds light on industry consolidation in times of excess capacity.

Abstract:
The intertemporal CAPM predicts that an asset's price is equal to the expectation of the product of the asset's payoff and a representative consumer's intertemporal marginal rate of substitution. This paper develops an alternative approach to assest pricing based on corporations' desire to hoard liquidity. Our corporate finance approach suggests new determinants of asset prices such as the distribution of wealth within the corporate sector and between the corporate sector and the consumers. Also, leverage ratios, capital adequacy requirements, and the composition of savings affect the corporate demand for liquid assets and therby interest rates.

This paper first sets up a general model of corporate demand for liquid assets, and obtains an explicit formula for the associated liquidity permia. It then derives some implications of corporate liquidity demand for the equity premium puzzle, for the yield curve, and for the state-contingent volatility of asset prices.

Abstract:
The intertemporal CAPM predicts that an asset's price is equal to the expectation of the product of the asset's payoff and a representative consum substitution. This paper develops an alternative approach to asset pricing based on industrial and financial corporations' desire to hoard liquidity to fulfill future cash needs. Our corporate finance a determinants of asset prices such as the distribution of wealth within the corporate sector and between the corporate sector and the consumers. Also, leverage ratios, capital adequacy requirements, and the composition of savings affect the corporate demand for liquid assets and thereby interest rates.

The paper first sets up a general model of corporate demand for liquid assets, and obtains an explicit formula for the associated liquidity permia. It then derives some implications of corporate liquidity demand for the equity premium puzzle, for the yield curve, and for the state-contingent volatility of asset prices. Finally, the paper looks at some macroeconomic implications of the theory. It shows that government may be able to boost aggregate liquidity and enhance economic efficiency by promoting job and asset price stability. On the liability side, long-term deposits and equity investments, which depend on the consumers' endogenously determined liquidity needs, contribute to creating a feedback effect between employment prospects and equity-like investments. On the asset side, orderly sales of real estate by liquidity-squeezed institutions may generate a Pareto improvement.

Abstract:
Executive compensation and corporate governance problems need to be seen in a larger historical context than is commonly done. The proximate causes of corporate scandals and executive pay problems have been identified, but the real drivers have not. A need for corporate restructuring, which emerged already in the 1970s, led to the remarkable rise in shareholder influence and the relentless pursuit for shareholder value. It placed exceptional demands on boards and led to extreme pay schemes that appear to have served the restructuring purposes well, but had unintended and unfortunate side-effects. In contemplating pay and governance reforms, it is essential to keep in mind the longer chain of events to avoid naive corrective measures that do not take into account the information and incentive constraints under which the various constituents and bodies in the larger governance system, especially the boards and shareholders, operate. Some of the recent advice on executive compensation seems very misguided in a longer historical perspective as is the push for extensive shareholder intervention rights.

Executive Compensation, Corporate Governance, Corporate Restructuring

Abstract:
The paper studies how a person's concern for a future career may influence his or her incentives to put in effort or make decisions on the job. In the model, the person's productive abilities are revealed over time through observations of performance. There are no explicit output contingent contracts, but since the wage in each period is based on expected output and expected output depends on assessed ability, an implicit contact' links today's performance to future wages. An incentive problem arises from the person's ability and desire to influence the learning process, and therefore the wage process, by taking unobserved actions that affect today's performance. The fundamental incongruity in preferences is between the individual's concern for human capital returns and the firm's concern for financial returns. The two need to be only weakly related. It is shown that career motives can be beneficial as well as detrimental, depending on how well the two kinds of capital returns are aligned.

Abstract:
This paper addresses a basic yet unresolved question: Do claims on private assets provide sufficient liquidity for an efficient functioning of the productive sector? Or does the State have a role in creating liquidity and regulating it either through adjustments in the stock of government securities or by other means? In our model, firms can meet future liquidity needs in three ways: by issuing new claims and diluting old ones, by obtaining a credit credit line from a financial intermediary, and by holding claims on other firms. When there is no aggregate uncertainty, we show that these instruments are sufficient for attaining the socially optimal (second-best) contract between investors and firms. Such a contract imposes both a maximum leverage ratio and a liquidity constraint on firms. Intermediaries coordinate the use of liquidity. Without intermediation, scarce liquidity may be wasted and the social optimum may not be attainable. When there is only aggregate uncertainty the private sector is no longer self-sufficient with regard to liquidity. The government can improve liquidity by issuing bonds that commit future consumer income. Government bonds command a liquidity premium over private claims. The supply of liquidity can be managed by loosening liquidity (boosting the value of its securities) when the aggregate liquidity shock is high and tightening liquidity when the shock is low. The paper thus provides a microeconomic example of government supplied liquidity as well as of the possibility of active government policy.

Abstract:
This paper addresses a basic, yet unresolved question: Do claims on private assets provide sufficient liquidity for an efficient functioning of the productive sector? Or does the State have a role in creating liquidity and regulating it either through adjustments in the stock of government securities or by other means? In our model, firms can meet future liquidity needs in three ways: by issuing new claims and diluting old ones, by obtaining a credit line from a financial intermediary, and by holding claims on other firms. When there is no aggregate uncertainty, we show that these instruments are sufficient for attaining the socially optimal (second-best) contract between investors and firms. Such a contract imposes both a maximum leverage ratio and a liquidity constraint on firms. Intermediaries coordinate the use of liquidity. Without intermediation, scarce liquidity may be wasted, and the social optimum may not be attainable. When there is only aggregate uncertainty, the private sector is no longer self-sufficient with regard to liquidity. The government can improve liquidity by issuing bonds that commit future consumer income. Government bonds command a liquidity premium over private claims. The government should manage the supply of liquidity by loosening liquidity (boosting the value of its securities) when the aggregate liquidity shock is high and tightening liquidity when the shock is low. The paper thus provides a microeconomic rationale for government- supplied liquidity as well as for an active government policy.

Abstract:
The existing literature on firms, based on incomplete contracts and property rights, emphasizes that the ownership of assets - and thereby firm boundaries - is determined in such a way as to encourage relationship-specific investments by the appropriate parties. It is generally accepted that this approach applies to owner-managed firms better than to large companies. In this paper, we attempt to broaden the scope of the property rights approach by developing a simple model with three key ingredients: (a) decision rights can be transferred ex ante through ownership, (b) managers (and possibly workers) enjoy private benefits that are non-transferable, and (c) owners can divert a firm's profit. In our basic model decisions are ex post non-contractible; in an extension we use the idea that contracts are reference points to relax this assumption. We show that firm boundaries matter. Nonintegrated firms fail to account for the external effects that their decisions have on other firms. An integrated firm can internalize such externalities, but it does not put enough weight on the private benefits of managers and workers. We explore this tradeoff in a model that focuses on the difficulties companies face in cooperating through the market if the benefits from cooperation are unevenly divided; therefore, they may sometimes end up merging. We show that the assumption that contracts are reference points introduces a friction that permits an analysis of delegation.

Abstract:
The paper studies how a person's concern for a future career may influence his or her incentives to put in effort or make decisions on the job. In the model, the person's productive abilities are revealed over time through observations of performance. There are no explicit output contingent contracts, but since the wage in each period is based on expected output and expected output depends on assessed ability, an "implicit contact" links today's performance to future wages. An incentive problem arises from the person's ability and desire to influence the learning process, and therefore the wage process, by taking unobserved actions that affect today's performance. The fundamental incongruity in preferences is between the individual's concern for human capital returns and the firm's concern for financial returns. The two need to be only weakly related. It is shown that career motives can be beneficial as well as detrimental, depending on how well the two kinds of capital returns are aligned.