The Internal Governance of Firms

48 Pages Posted: 7 Apr 2009  

Viral V. Acharya

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

Stewart C. Myers

Massachusetts Institute of Technology (MIT); National Bureau of Economic Research (NBER)

Raghuram G. Rajan

University of Chicago - Booth School of Business; International Monetary Fund (IMF); National Bureau of Economic Research (NBER)

Multiple version iconThere are 5 versions of this paper

Date Written: March 2009

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.

Keywords: Agency theory, Corporate governance, Dividends, Internal organization, Short-termism

JEL Classification: D23, G31, G32, G34, G35, L21, M51

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

Viral V. Acharya (Contact Author)

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

44 West 4th Street
New York, NY NY 10012
United States

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

Centre for Economic Policy Research (CEPR)

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London, EC1V 3PZ
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National Bureau of Economic Research (NBER)

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New York University (NYU) - Department of Finance

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

Stewart C. Myers

Massachusetts Institute of Technology (MIT) ( email )

Sloan School of Management
Cambridge, MA 02142
United States
617-253-6696 (Phone)
617-258-6855 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Raghuram G. Rajan

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-4437 (Phone)
773-702-0458 (Fax)

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States
773-702-9299 (Phone)
773-702-0458 (Fax)

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