Viral V. Acharya, Stewart C. Myers, and Raghuram G. Rajan [Archive.org URL]

The traditional description of the firm – an organization run by top managers and monitored by a board of directors on behalf of public shareholders – falls short on three counts. First, control need not be exerted just top down, or from outside, it can also be asserted bottom-up. Put differently, the CEO has to give his subordinates a reason to follow, and this, implicitly, is how they control him. Second, the view that there is one residual claimant in the firm, the shareholder, is probably too narrow. Anyone who shares in the quasi-rents generated by the firm has some residual claims, and thus there is no easy equivalence between maximizing shareholder value and maximizing efficiency. Third, the fact that different parties have claims to different residual rents at different horizons means each one has to pay attention to the others’ residual claims in order to elicit cooperation. The checks that parties inside the firm impose on each other ensure the firm functions well, even if outside control is weak.

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