An Empirical Investigation of Internal Governance

50 Pages Posted: 15 Mar 2012

See all articles by Huijing Fu

Huijing Fu

Texas Christian University

Rajesh K. Aggarwal

Northeastern University

Yihui Pan

University of Utah - Department of Finance

Date Written: March 14, 2012

Abstract

Acharya, Myers, and Rajan (2011) theorize that self-serving actions and rent extraction by CEOs can be constrained by subordinate managers when the managers' efforts are needed in production. This force, which they call internal governance, works best when the CEO and the managers are both important to firm output, in the sense that their relative contributions to firm value are balanced. We empirically examine the effects of internal governance on firm investment and performance. We develop a measure of internal governance that captures the relative contribution of the CEO compared to non-CEO executives in firm value creation. Consistent with the theory, we find that there is a hump-shaped relation between relative contributions and corporate investment measured as either capital expenditures or R&D spending. We also find a hump-shaped relation between relative contributions and several measures of firm performance such as Tobin's Q and free cash flow. The hump-shaped relations between investment and relative contributions and between firm performance and relative contributions are more evident for firms with a greater age difference between the CEO and the managers, firms in growing industries, firms with non-founder CEOs or CEOs without substantial equity ownership, firms with weaker external monitoring, and firms in which internal managers are more likely to become CEO in the future. Further, neither external governance nor board governance diminishes the importance of internal governance. Overall, our results are strongly supportive of the theory.

Suggested Citation

Fu, Huijing and Aggarwal, Rajesh K. and Pan, Yihui, An Empirical Investigation of Internal Governance (March 14, 2012). AFA 2013 San Diego Meetings Paper. Available at SSRN: https://ssrn.com/abstract=2022709 or http://dx.doi.org/10.2139/ssrn.2022709

Huijing Fu (Contact Author)

Texas Christian University ( email )

Fort Worth, TX 76129
United States
817-257-7148 (Phone)
817-257-7227 (Fax)

Rajesh K. Aggarwal

Northeastern University ( email )

413 Hayden Hall
360 Huntington Avenue
Boston, MA 02115
United States

Yihui Pan

University of Utah - Department of Finance ( email )

David Eccles School of Business
Salt Lake City, UT 84112
United States

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