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We develop a model of internal governance where the self-serving actions of top management are limited by the potential reaction of subordinates. Internal governance can mitigate agency problems and ensure that firms have substantial value, even with little or no external governance by investors. External governance, even if crude and uninformed, can complement internal governance and improve efficiency. This leads to a theory of investment and dividend policy, where dividends are paid by self-interested CEOs to maintain a balance between internal and external control. Our paper can explain why partnerships work well even if control rights are concentrated at the top, why a public firm’s shares have value even when shareholders have limited power, and when structuring an entity as a publicly-held firm is better than structuring it as a partnership.

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