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Title: Corporate Governance Externalities

Author(s): Viral V. Acharya and Paolo Volpin

Publication Date: January 2008

Keyword(s): corporate governance, executive compensation, externality, governance standards, ownership structure and regulation

Programme Area(s): Financial Economics

Abstract: We argue that the choice of corporate governance by a firm affects and is affected by the choice of governance by other firms. Firms with weaker governance give higher payoffs to their management to incentivize them. This forces firms with good governance to also pay their management more than they would otherwise, due to competition in the managerial labour market. This externality reduces the value to firms of investing in corporate governance and produces weaker overall governance in the economy. The effect is stronger the greater the competition for managers and the stronger the managerial bargaining power. While standards can help raise governance towards efficient levels, market-based mechanisms such as (i) the acquisition of large equity stakes by raiders and (ii) the need to raise external capital by firms can help too, and we characterize conditions under which this happens.

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Bibliographic Reference

Acharya, V and Volpin, P. 2008. 'Corporate Governance Externalities'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=6627