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Review of Finance Advance Access published online on April 14, 2009
Review of Finance, doi:10.1093/rof/rfp002
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© The Authors 2009. Published by Oxford University Press on behalf of the European Finance Association. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org

Corporate Governance Externalities*

Viral V. Acharya1 and Paolo F. Volpin2

1 London Business School, New York University Stern School of Business and CEPR
2 London Business School, ECGI and CEPR

When firms compete in the managerial labor market, the choice of corporate governance by a firm affects, and is affected by, the choice of governance by other firms. Firms with weaker governance offer managers more generous incentive compensation, which induces firms with good governance to also overpay their management. Due to this externality, overall level of governance in the economy can be inefficiently low. Poor governance can in fact be employed by incumbent firms to deter entry by new firms. Such corporate governance externalities have important implications for regulatory standards, ownership structure of firms, and the market for corporate control.

Key Words: G34 • J63 • K22 • K42 • L14

* We thank Franklin Allen, Ramin Baghai-Wadji, Marc Gabarro, Marco Pagano, Zacharias Sautner and seminar participants at the Corporate Governance Symposium held in Oxford, ECGI Best Paper Competition held in Stockholm, European Finance Association 2008 meetings, Law and Finance seminar at NYU-Stern, London Business School, University of Cambridge, University of Salerno and Warwick Business School.


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