Towards a New Theory of Corporate Governance: Objectivity Versus Proximity
35 Pages Posted: 21 Mar 2005
Date Written: February 21, 2005
In this paper we identify the tradeoffs between objectivity and proximity as fundamental to the corporate governance debate. We stress the value of objectivity that comes with distance (e.g., the market-oriented U.S. system), and the value of better information that comes with proximity (e.g., the more intrusive Continental European model). Our key result is that the optimal arrangement between management and monitor (board or shareholders) should either capitalize on the better information that comes with proximity or seek to optimally exploit the objectivity that comes with distance. We argue that the asset structure, in particular, the irreversibility of investments, and the opportunity costs associated with resource misallocation critically determine the optimality of the distance- or proximity-based arrangement. We also discuss the ways in which investors have contracted around the flaws in their own corporate governance systems, pointing at the adaptibility of different arrangements.
Keywords: Corporate governance, monitoring, asset structure
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