The final section concludes with some observations and recommendations as to the most important steps that might be taken to improve corporate governance, under the conditions prevailing in these countries. The special role of equity owners is that they are the residual risk-bearers of the firm. Their claim is only to whatever is left after all prior claims have been paid lenders' principal or interest, employees' salaries, suppliers' bills, government taxes. One answer is that the managers have a stake in their own reputation, if they contemplate raising more equity in capital markets to support expan- sion of the firm. And it often has been observed that many large firms rely more on retained earnings than on new equity offerings.
Reputation is no doubt a constraint, but an uncertain one.
A second answer is that, under most legal systems, shareholders have the power to elect a governing board, which in turn selects the managers who make the actual operating decisions, including decisions as to salaries and dividend payments. In theory, managers who reward themselves excessively or perform incompetently may be replaced by the shareholders. In practice, this will depend on whether the shareholders are able to take effective col- lective action, and that in turn depends on a host of considerations to which I shall return. A third answer is that a set of legal rules may limit the ability of man- agers to act in ways that benefit themselves and harm shareholders. These answers to the pervasive problem of agency costs are not mutually exclusive but are potentially complementary.