Working Paper: CEPR ID: DP7210
Authors: Viral V. Acharya; Stewart C. Myers; Raghuram G. Rajan
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 Codes: D23; G31; G32; G34; G35; L21; M51
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| internal governance (G38) | firm value (G32) |
| subordinate reactions (Y80) | CEO behavior (M12) |
| CEO self-interest (M12) | subordinate contributions (D10) |
| external governance (G38) | internal governance (G38) |
| dividends (G35) | CEO control (M12) |
| investment decisions (G11) | managerial effort (D29) |