Looking the Other Way: The Screening Role of (Weak) Internal Governance

52 Pages Posted: 8 Feb 2021 Last revised: 2 Mar 2022

See all articles by Felix Zhiyu Feng

Felix Zhiyu Feng

University of Washington - Michael G. Foster School of Business

Wenyu Wang

Indiana University - Kelley School of Business - Department of Finance

Yufeng Wu

University of Illinois at Urbana-Champaign - Department of Finance

Date Written: February 25, 2022

Abstract

We analyze the role of internal governance in a dynamic adverse selection model in which managers have unobservable ability and must be given rents through a compensation contract in exchange for revealing their private information. Governance has an ex-post disciplining effect, whereby stronger governance limits the information advantage and the rents managers with higher ability can extract. Meanwhile, governance has an ex-ante screening effect, whereby weaker governance allows firms to attract on-average better managers. An optimal level of governance balancing the disciplining and the screening effects can exist, even when governance is intrinsically costless and can be made arbitrarily strong.

Keywords: internal governance, board of directors, dynamic adverse selection, persistent private information, screening

JEL Classification: G32, G34, D82, D86, M12

Suggested Citation

Feng, Felix and Wang, Wenyu and Wu, Yufeng, Looking the Other Way: The Screening Role of (Weak) Internal Governance (February 25, 2022). Available at SSRN: https://ssrn.com/abstract=3775306 or http://dx.doi.org/10.2139/ssrn.3775306

Felix Feng (Contact Author)

University of Washington - Michael G. Foster School of Business ( email )

Box 353200
Seattle, WA 98195-3200
United States

Wenyu Wang

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States

Yufeng Wu

University of Illinois at Urbana-Champaign - Department of Finance ( email )

1206 South Sixth Street
Champaign, IL 61820
United States

HOME PAGE: http://https://business.illinois.edu/profile/yufeng-wu2/

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