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The Internal Governance of Firms

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  • 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.
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Suggested Citation

  • Viral V. Acharya & Stewart C. Myers & Raghuram G. Rajan, 2011. "The Internal Governance of Firms," Journal of Finance, American Finance Association, vol. 66(3), pages 689-720, June.
    • Handle: RePEc:bla:jfinan:v:66:y:2011:i:3:p:689-720
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    More about this item

    JEL classification:

    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy
    • L21 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Business Objectives of the Firm
    • M51 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Firm Employment Decisions; Promotions

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