Corporate Governance and Firm Value: The Economics of Boards, Ownership, and Executive Compensation

Abstract

This paper surveys the economics of corporate governance, the set of mechanisms by which shareholders and other outside stakeholders limit the discretion of the managers who control large corporations. The intellectual foundations lie in the observation of Berle and Means (1932) that the modern corporation separates ownership from control, and in the agency theory of Jensen and Meckling (1976), which analyzes the costs that arise when the interests of managers and shareholders diverge. The survey examines four families of governance mechanisms. First, ownership structure, from concentrated blockholders to the rise of institutional investors, determines who monitors managers and how effectively. Second, boards of directors serve as the central internal monitor, but their independence, size, and effectiveness are themselves endogenous outcomes. Third, executive compensation aligns managerial incentives with shareholder wealth, although its design and level raise questions about rent extraction. Fourth, external mechanisms, above all the market for corporate control, discipline managers who fail to maximize value. The survey then considers the role of law and investor protection, the measurement of corporate governance, and the empirical evidence linking governance to firm value. Throughout, the emphasis is on the economic logic that connects these mechanisms and on the practical and policy debates they generate.