Corporate Governance Externalities

49 Pages Posted: 20 Dec 2007 Last revised: 1 Mar 2009

See all articles by Viral V. Acharya

Viral V. Acharya

New York University - Leonard N. Stern School of Business; New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

Paolo F. Volpin

City University London - Faculty of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Multiple version iconThere are 4 versions of this paper

Date Written: August 2008

Abstract

When firms compete in the managerial labor market, the choice of corporate governance by a firm affects, and is affected by, the choice of governance by other firms. Firms with weaker governance offer managers more generous compensation packages to incentivize them. This behavior forces firms with good governance to pay their management more than they would otherwise. 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. The need to raise external capital by firms can improve governance levels not just in the firms that are directly affected by these mechanisms, but also in the competing firms. However, poor governance can also be employed by incumbent firms as a strategic deterrent to entry by new firms. We discuss the implications of this externality view of corporate governance for regulatory standards, ownership structure of firms, and the market for corporate control.

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

JEL Classification: G34, J63, K22, K42, L14

Suggested Citation

Acharya, Viral V. and Volpin, Paolo F., Corporate Governance Externalities (August 2008). ECGI - Finance Working Paper No. 195/2008, Available at SSRN: https://ssrn.com/abstract=1076522 or http://dx.doi.org/10.2139/ssrn.1076522

Viral V. Acharya (Contact Author)

New York University - Leonard N. Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States

HOME PAGE: http://pages.stern.nyu.edu/~sternfin/vacharya/public_html/~vacharya.htm

New York University (NYU) - Department of Finance

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Paolo F. Volpin

City University London - Faculty of Finance ( email )

London, EC2Y 8HB
Great Britain

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http:/www.ecgi.org

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