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This article establishes a role for corporate governance regulation. An externality operating through executive compensation motivates regulation. Governance lowers agency costs, allowing firms to grant less incentive pay. When a firm increases governance and lowers incentive pay, other firms can also lower executive compensation. Because firms do not internalize the full benefit of governance, regulation can improve investor welfare. When regulation is enforced, large firms increase in value, small firms decrease in value, and all firms lower incentive pay. Distinct cross-sectional and cross-country predictions for the number of voluntary governance firms are provided. The Author 2012. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.
David L. Dicks (Mon,) studied this question.