The Entrenchment Problem, Corporate Governance Mechanisms and Firm Value

In this paper, we investigate the effectiveness of two main corporate governance mechanisms, namely the board of directors and auditing, in mitigating the equity discounts arising from the potential entrenchment problem between inside and outside shareholders. Overall, the empirical results suggest that both boards with equity incentives and higher quality auditors may act as effective governance mechanisms with positive valuation implications. The monitoring incentives of the board of directors appear to play a key governance role. Specifically, we find that boards where board members have invested their personal wealth in the firm demand more stringent auditing, claim higher dividends and thereby limit the agency problem of free cash flow