The Effect Of Capital Structure When Expected Agency Costs Are Extreme
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| Author | : Campbell R. Harvey |
| Publisher | : |
| Total Pages | : 32 |
| Release | : 2001 |
| Genre | : Capital |
| ISBN | : |
We provide new evidence that debt creates shareholder value for firms that face agency costs. Our tests are unique in two respects. First, we focus on a sample of firms with potentially extreme agency problems. We study emerging market firms where the routine use of pyramid ownership structures provides an acute separation of management cash flow rights and control rights. Second, we argue that not all debt is the same. Using new data on global debt issuance, we find that the type of debt that positively impacts shareholder value is the type that closely monitors management. This combination of a sample of firms with extreme expected agency problems and detailed information on the different types of debt allows us to construct powerful tests of whether debt can mitigate the effects of agency and information problems. Among other results, we find that the abnormal returns resulting from syndicated term loans (which provide monitoring) are significantly related to the extent of the separation of ownership and control. Our results are consistent with the idea that debt creates value because it reduces the agency costs associated with overinvestment
| Author | : Campbell R. Harvey |
| Publisher | : |
| Total Pages | : 45 |
| Release | : 2010 |
| Genre | : |
| ISBN | : |
We provide new evidence that debt creates shareholder value for firms that face agency costs. Our tests are unique in two respects. First, we focus on a sample of firms with potentially extreme agency problems. We study emerging market firms where the routine use of pyramid ownership structures provides an acute separation of management cash flow rights and control rights. Second, we argue that not all debt is the same. Using new data on global debt issuance, we find that the type of debt that positively impacts shareholder value is the type that closely monitors management. This combination of a sample of firms with extreme expected agency problems and detailed information on the different types of debt allows us to construct powerful tests of whether debt can mitigate the effects of agency and information problems. Among other results, we find that the abnormal returns resulting from syndicated term loans (which provide monitoring) are significantly related to the extent of the separation of ownership and control. Our results are consistent with the idea that debt creates value because it reduces the agency costs associated with overinvestment.
| Author | : Karl V. Lins |
| Publisher | : |
| Total Pages | : 40 |
| Release | : 2003 |
| Genre | : |
| ISBN | : |
This paper conducts powerful new tests of whether debt can mitigate the effects of agency and information problems. We focus on emerging market firms for which pyramid ownership structures create potentially extreme managerial agency costs. Our tests incorporate both traditional financial statement data and new data on global debt contracts. Our analysis is mindful of the potential endogeneity between debt, ownership structure, and value, and takes into account differences in the debt capacity of a firm's assets in place and future growth opportunities. The results indicate that the incremental benefit of debt is concentrated in firms with high expected managerial agency costs that are also most likely to have overinvestment problems resulting from high levels of assets in place or limited future growth opportunities. Subsequent internationally syndicated term loans are particularly effective at creating value for these firms. Our results support the recontracting hypothesis that equity holders value compliance with monitored covenants, particularly when firms are likely to overinvest.
| Author | : Benjamin M. Friedman |
| Publisher | : University of Chicago Press |
| Total Pages | : 404 |
| Release | : 2009-05-15 |
| Genre | : Business & Economics |
| ISBN | : 0226264238 |
The research reported in this volume represents the second stage of a wide-ranging National Bureau of Economic Research effort to investigate "The Changing Role of Debt and Equity in Financing U.S. Capital Formation." The first group of studies sponsored under this project, which have been published individually and summarized in a 1982 volume bearing the same title (Friedman 1982), addressed several key issues relevant to corporate sector behavior along with such other aspects of the evolving financial underpinnings of U.S. capital formation as household saving incentives, international capital flows, and government debt management. In the project's second series of studies, presented at the National Bureau of Economic Research conference in January 1983 and published here for the first time along with commentaries from that conference, the central focus is the financial side of capital formation undertaken by the U.S. corporate business sector. At the same time, because corporations' securities must be held, a parallel focus is on the behavior of the markets that price these claims.
| Author | : Kevin C. W. Chen |
| Publisher | : |
| Total Pages | : 69 |
| Release | : 2009 |
| Genre | : |
| ISBN | : |
In this paper, we examine the effect of shareholder rights on reducing the cost of equity and the impact of agency problems from free cash flow on this effect. We find that firms with strong shareholder rights have a significantly lower implied cost of equity after controlling for risk factors, price momentum, analysts' forecast biases, and industry effects than do firms with weak shareholder rights. Further analysis shows that the effect of shareholder rights on reducing the cost of equity is significantly stronger for firms with more severe agency problems from free cash flows.
| Author | : Antonio Mello |
| Publisher | : Forgotten Books |
| Total Pages | : 40 |
| Release | : 2018-02-25 |
| Genre | : Business & Economics |
| ISBN | : 9780666358035 |
Excerpt from The Agency Cost of Alternative Debt Instruments It is now commonly recognized that a firm's capital structure can affect its value through the incentives that are created for the equity holders in favor of one or another investment and operating policy. A place has therefore been created for a positive theory of capital structure. Missing, however, from the literature on agency costs in finance have been models that enable us to measure the effects of capital structure on the value of the firm's assets. In this paper we show how contingent claims models can be used to measure and compare the agency costs of different forms of debt-fixed rate and indexed. The model can be used to determine the optimal indexing structure and the optimal parameters of the debt contract. The case of index linked debt that we study in this paper is a commodity bond. About the Publisher Forgotten Books publishes hundreds of thousands of rare and classic books. Find more at www.forgottenbooks.com This book is a reproduction of an important historical work. Forgotten Books uses state-of-the-art technology to digitally reconstruct the work, preserving the original format whilst repairing imperfections present in the aged copy. In rare cases, an imperfection in the original, such as a blemish or missing page, may be replicated in our edition. We do, however, repair the vast majority of imperfections successfully; any imperfections that remain are intentionally left to preserve the state of such historical works.
| Author | : Michael C. Jensen |
| Publisher | : Harvard University Press |
| Total Pages | : 342 |
| Release | : 2003-09-30 |
| Genre | : Business & Economics |
| ISBN | : 9780674012295 |
This collection examines the forces, both external and internal, that lead corporations to behave efficiently and to create wealth. Corporations vest control rights in shareholders, the author argues, because they are the constituency that bear business risk and therefore have the appropriate incentives to maximize corporate value. Assigning control to any other group would be tantamount to allowing that group to play poker with someone else's money, and would create inefficiencies. The implicit denial of this proposition is the fallacy of the so-called stakeholder theory of the corporation, which argues that corporations should be run in the interests of all stakeholders. This theory offers no account of how conflicts between different stakeholders are to be resolved, and gives managers no principle on which to base decisions, except to follow their own preferences. In practice, shareholders delegate their control rights to a board of directors, who hire, fire, and set the compensation of the chief officers of the firm. However, because agents have different incentives than the principals they represent, they can destroy corporate value unless closely monitored. This happened in the 1960s and led to hostile takeovers in the market for corporate control in the 1970s and 1980s. The author argues that the takeover movement generated increases in corporate efficiency that exceeded $1.5 trillion and helped to lay the foundation for the great economic boom of the 1990s.
| Author | : Michael McDonald |
| Publisher | : |
| Total Pages | : |
| Release | : 2017 |
| Genre | : |
| ISBN | : |
We examine the impact of two defining social characteristics (individualism and risk aversion) and their interaction with governance and firm agency problems on capital structure in the G20 countries. With a sample of roughly 13,000 firms from 1995 to 2009, we show that higher levels of individualism are associated with increased firm use of debt and lower cost of capital, whereas higher risk aversion has the opposite effects. All else equal, better firm-level governance substantially reduces these cultural effects, as does larger firm size, and less research-intensity at the firm. To address endogeneity concerns, we use a propensity score matching procedure and show that our results continue to hold. Our results are also robust to alternative measures of culture, firm-level governance and agency costs, debt cost of capital, bankruptcy risk, identification concerns, and other country level effects.
| Author | : Paul D. Childs |
| Publisher | : |
| Total Pages | : 52 |
| Release | : 2008 |
| Genre | : |
| ISBN | : |
In a dynamic continuous-time model, we examine the impact of a manager-shareholder conflict over the choice of investment risk on firm value and optimal capital structure. The manager's optimal investment risk policy is substantially different from the policy that maximizes equity or total firm value. The resulting agency costs of equity are many times larger than the agency costs of debt. Among a number of important implications, we find that managerial risk-aversion decreases the agency costs of equity. We also find that when equityholders have control rights over financing decisions, optimal leverage may increase relative to optimal leverage when investment risk is chosen to maximize total firm value. Additionally, greater managerial equity compensation may exacerbate the manager-stockholder conflict over investment policy, and in spite of higher agency costs of equity, may increase optimal leverage. Finally, we find that an increase in risk encourages the manager to pursue a more conservative investment strategy, which increases the agency costs of equity. Managerial risk-aversion, however, acts to mitigate this effect of risk on the agency costs of equity.
| Author | : Yilei Zhang |
| Publisher | : |
| Total Pages | : 40 |
| Release | : 2013 |
| Genre | : |
| ISBN | : |
This paper investigates the influence of managerial incentives on the capital structure decision using a sample of all-equity firms. Managerial risk-taking incentives may encourage financial risk taking hence greater leverage. On the other hand, increasing a manager's incentive to take risk increases the agency cost of debt and therefore lowers debt capacity. I provide evidence supporting the second effect in all-equity firms where the potential asset substitution is more severe. I show that CEO's pay-for-performance sensitivity (delta) and the sensitivity of CEO wealth to stock volatility (vega) are higher in all-equity firms than those in matched levered firms. In addition, the incentive compensation in all-equity firms encourages greater risk-taking activities than levered firms, suggesting a negative relation between leverage and risk taking incentives. I also find that the likelihood of having an all-equity capital structure increases in the risk taking incentives from managerial equity-based compensation. This remains after controlling for endogeneity, which may arise if overcoming managerial risk aversion is particularly important for these all-equity firms. Finally, I find that equity-based compensation and incentives decrease upon firms' switching to levered firms from all-equity firms, indicating the change of compensation structure is associated with the change of capital structure.
