48 Pages Posted: 7 Apr 2009
Date Written: March 2009
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.
Keywords: Agency theory, Corporate governance, Dividends, Internal organization, Short-termism
JEL Classification: D23, G31, G32, G34, G35, L21, M51
Suggested Citation: Suggested Citation
Acharya, Viral V. and Myers, Stewart C. and Rajan, Raghuram G., The Internal Governance of Firms (March 2009). CEPR Discussion Paper No. DP7210. Available at SSRN: https://ssrn.com/abstract=1372530
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