Theoretical Essays on Corporate Governance in Theory of Finance

Mixed Motives and Agency Conflict in Asset Pricing: The paper considers two main problems of conflict of interest called the mixed motive, or empirebuilding, and agency conflict. It employs heterogeneous-agent production-base asset pricing model as in Albuquerue and Wang (2008). We consider the effect of separation of ownership and control between controlling shareholder, who entrench and control all decisions of the firm, and outside shareholder, who simply allocate resource between consumption and investment in risk-free and risky asset. By having all corporate control, the controlling shareholder could steal the corporate resource or to do empire-building investment. We characterize the No-Trade equilibrium and conduct comparative static analysis of investment, dividend, interest rate and equity premium with respect to level of investor protection, corporate ownership of controlling shareholder and level of empirebuilding decision.

Internal Governance, Investment and Security Design: This paper studies the role of internal governance in dynamic context of the firm using continuous-time dynamic contract model. The internal governance limits the amount of capital diversion, but the manager's decisions on effort and capital diversion are unobservable. We characterize the optimal dynamic contract with governance. An implementation of optimal contract shows the value of governance mechanism in security price as a separate contribution from operational profit and executive compensation. This value has dynamic context because it changes over time due to the expected longevity of the firm. An increase in internal governance intensifies the dynamic incentive alignment between the manager's compensation and firm's performance. A governance change is in essence a reallocation of the weight between instantaneous and intertemporal incentive of the manager. We also show that investor's benefit from better governance changes over time, depending on the firm's stage. Our results provide dynamic framework of governance mechanism, give an insight on time-inconsistency in corporate finance, explain the recent empirical puzzle and suggest its remedy for the empirical study on corporate governance and equity price.