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The Neglected Role of Justification Under Uncertainty in Corporate Governance and Finance
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The Neglected Role of Justification under Uncertainty in Corporate Governance and Finance does three novel things. First, it demonstrates that the need to justify is pervasive and identifies a type of agency cost -- "justification costs" -- resulting from decisions motivated by justification. Second, it considers the relationship between these sorts of agency costs and more traditional agency costs, such as those involving self-dealing or empire building. Third, and most importantly, it introduces a role for uncertainty. Under conditions of low(er) uncertainty, more accountability does not nec...
The Neglected Role of Justification under Uncertainty in Corporate Governance and Finance does three novel things. First, it demonstrates that the need to justify is pervasive and identifies a type of agency cost -- "justification costs" -- resulting from decisions motivated by justification. Second, it considers the relationship between these sorts of agency costs and more traditional agency costs, such as those involving self-dealing or empire building. Third, and most importantly, it introduces a role for uncertainty. Under conditions of low(er) uncertainty, more accountability does not necessarily increase justification costs, which are apt to be low in any event, and does reduce traditional agency costs. But under conditions of uncertainty, accountability increases justification costs, potentially in an amount greater than any reduction in traditional agency costs; under some circumstances, reducing accountability, thereby granting managers more leeway, may be preferable. The authors propose a mechanism by which managers and stockholders can agree on granting managers some leeway for a specified period of time, in the form of "Control-Enhancing-Mechanisms" (CEMs). They consider how the existence of justification costs might apply in some private and public financial contexts, and suggest some solutions in those contexts as well.
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