The Internal Governance of Firms





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    • NYU-Stern, CEPR, ECGI, and NBER; MIT and NBER; and University of Chicago Booth School of Business and NBER. We thank Ashwini Agrawal, Franklin Allen, Effi Benmelech, John Coates, Douglas Diamond, Alex Edmans, Maryam Farboodi, Milton Harris, Roni Kisin, Mark Rubinstein, Amit Seru, Jeremy Stein, Raghu Sundaram, Rob Vishny, Michael Weisbach, Luigi Zingales, and seminar participants at AEA Meetings (2010), Canadian Corporate Governance Institute, UC Berkeley, Chicago Booth, Harvard, Michigan State, MIT, NBER Corporate Finance Workshop (Fall 2008), NBER Law and Economics (Spring 2010), NYU Financial Economics Workshop, NYU-Stern, Federal Reserve Bank of Philadelphia, Tuck, UCLA, and the Western Finance Association (WFA 2009) for helpful conversations and comments. Ramin Baghai and Hanh Le provided excellent research assistance. Raghuram Rajan acknowledges support from the Center for Research on Securities Prices at the University of Chicago, the National Science Foundation, the Stigler Center, and the Initiative on Global Markets. Acharya is grateful for research support from the ESRC (Grant No. R060230004 awarded to the London Business School Corporate Governance Center).


We develop a model of internal governance where the self-serving actions of top management are limited by the potential reaction of subordinates. Internal governance can mitigate agency problems and ensure that firms have substantial value, even with little or no external governance by investors. External governance, even if crude and uninformed, can complement internal governance and improve efficiency. This leads to a theory of investment and dividend policy, in which dividends are paid by self-interested CEOs to maintain a balance between internal and external control.