IDEAS home Printed from https://ideas.repec.org/a/eee/jbfina/v35y2011i1p36-50.html
   My bibliography  Save this article

Managerial entrenchment, equity payout and capital structure

Author

Listed:
  • Wang, Hao

Abstract

I develop a contingent claims model to examine the impacts of managerial entrenchment on capital structure and security valuation. The analysis shows that managers' self-interested leverage choices deviate significantly from the optimal leverages that maximize firm values, partially explaining the suboptimal leverage ratios observed empirically (Graham, 2000). Both the extent and sensitivity of the deviations are affected by firm characteristics, debt features and default solutions. The shareholder-manager conflicts over risk level and cash payout vary dynamically with a firm's financial health. Managerial entrenchment does not mitigate the agency problems of debt since managers' discretionary decisions on milking properties or asset substitution could be driven by incentives to increase their own utility.

Suggested Citation

  • Wang, Hao, 2011. "Managerial entrenchment, equity payout and capital structure," Journal of Banking & Finance, Elsevier, vol. 35(1), pages 36-50, January.
    • Handle: RePEc:eee:jbfina:v:35:y:2011:i:1:p:36-50
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0378-4266(10)00276-1
    Download Restriction: Full text for ScienceDirect subscribers only
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Ivo Welch, 2004. "Capital Structure and Stock Returns," Journal of Political Economy, University of Chicago Press, vol. 112(1), pages 106-131, February.
    2. Stulz, ReneM., 1988. "Managerial control of voting rights : Financing policies and the market for corporate control," Journal of Financial Economics, Elsevier, vol. 20(1-2), pages 25-54, January.
    3. Liao, Hsien-Hsing & Chen, Tsung-Kang & Lu, Chia-Wu, 2009. "Bank credit risk and structural credit models: Agency and information asymmetry perspectives," Journal of Banking & Finance, Elsevier, vol. 33(8), pages 1520-1530, August.
    4. Berger, Philip G & Ofek, Eli & Yermack, David L, 1997. "Managerial Entrenchment and Capital Structure Decisions," Journal of Finance, American Finance Association, vol. 52(4), pages 1411-1438, September.
    5. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    6. Joan Farre-Mensa & Roni Michaely & Martin Schmalz, 2014. "Payout Policy," Annual Review of Financial Economics, Annual Reviews, vol. 6(1), pages 75-134, December.
    7. Leland, Hayne E, 1994. "Corporate Debt Value, Bond Covenants, and Optimal Capital Structure," Journal of Finance, American Finance Association, vol. 49(4), pages 1213-1252, September.
    8. Sanford J. Grossman & Oliver D. Hart, 1982. "Corporate Financial Structure and Managerial Incentives," NBER Chapters, in: The Economics of Information and Uncertainty, pages 107-140, National Bureau of Economic Research, Inc.
    9. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-329, May.
    10. Yermack, David, 1996. "Higher market valuation of companies with a small board of directors," Journal of Financial Economics, Elsevier, vol. 40(2), pages 185-211, February.
    11. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    12. repec:bla:jfinan:v:53:y:1998:i:4:p:1213-1243 is not listed on IDEAS
    13. Leland, Hayne E & Toft, Klaus Bjerre, 1996. "Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads," Journal of Finance, American Finance Association, vol. 51(3), pages 987-1019, July.
    14. King, Michael R. & Santor, Eric, 2008. "Family values: Ownership structure, performance and capital structure of Canadian firms," Journal of Banking & Finance, Elsevier, vol. 32(11), pages 2423-2432, November.
    15. Zwiebel, Jeffrey, 1996. "Dynamic Capital Structure under Managerial Entrenchment," American Economic Review, American Economic Association, vol. 86(5), pages 1197-1215, December.
    16. Mark Broadie & Mikhail Chernov & Suresh Sundaresan, 2007. "Optimal Debt and Equity Values in the Presence of Chapter 7 and Chapter 11," Journal of Finance, American Finance Association, vol. 62(3), pages 1341-1377, June.
    17. Fan, Hua & Sundaresan, Suresh M, 2000. "Debt Valuation, Renegotiation, and Optimal Dividend Policy," The Review of Financial Studies, Society for Financial Studies, vol. 13(4), pages 1057-1099.
    18. Bart M. Lambrecht & Stewart C. Myers, 2007. "A Theory of Takeovers and Disinvestment," Journal of Finance, American Finance Association, vol. 62(2), pages 809-845, April.
    19. Altman, Edward I, 1984. "A Further Empirical Investigation of the Bankruptcy Cost Question," Journal of Finance, American Finance Association, vol. 39(4), pages 1067-1089, September.
    20. Gillan, Stuart L. & Starks, Laura T., 2000. "Corporate governance proposals and shareholder activism: the role of institutional investors," Journal of Financial Economics, Elsevier, vol. 57(2), pages 275-305, August.
    21. John R. Graham, 2000. "How Big Are the Tax Benefits of Debt?," Journal of Finance, American Finance Association, vol. 55(5), pages 1901-1941, October.
    22. Isabelle Huault & V. Perret & S. Charreire-Petit, 2007. "Management," Post-Print halshs-00337676, HAL.
    23. Rosenstein, Stuart & Wyatt, Jeffrey G., 1990. "Outside directors, board independence, and shareholder wealth," Journal of Financial Economics, Elsevier, vol. 26(2), pages 175-191, August.
    24. Stewart C. Myers, 2000. "Outside Equity," Journal of Finance, American Finance Association, vol. 55(3), pages 1005-1037, June.
    25. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    26. Ferris, Stephen P. & Jayaraman, Narayanan & Sabherwal, Sanjiv, 2009. "Catering effects in corporate dividend policy: The international evidence," Journal of Banking & Finance, Elsevier, vol. 33(9), pages 1730-1738, September.
    27. Hayne E. Leland., 1998. "Agency Costs, Risk Management, and Capital Structure," Research Program in Finance Working Papers RPF-278, University of California at Berkeley.
    28. Pascal Francois, 2004. "Capital Structure and Asset Prices: Some Effects of Bankruptcy Procedures," The Journal of Business, University of Chicago Press, vol. 77(2), pages 387-412, April.
    29. Anderson, Ronald W & Sundaresan, Suresh, 1996. "Design and Valuation of Debt Contracts," The Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 37-68.
    30. Harris, Milton & Raviv, Artur, 1989. "The design of securities," Journal of Financial Economics, Elsevier, vol. 24(2), pages 255-287.
    31. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
    32. Erwan Morellec, 2004. "Can Managerial Discretion Explain Observed Leverage Ratios?," The Review of Financial Studies, Society for Financial Studies, vol. 17(1), pages 257-294.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Kim, Tae-Nyun & Kim, Kihun, 2018. "External cost of leverage adjustment: Evidence from defined benefit pension plans," Journal of Economics and Business, Elsevier, vol. 96(C), pages 1-14.
    2. Huang, Guan-Ying & Huang, Henry H. & Lee, Chun I, 2019. "Is CEO pay disparity relevant to seasoned bondholders?," International Review of Economics & Finance, Elsevier, vol. 64(C), pages 271-289.
    3. Meng, Rujing & Ning, Xiangdong & Zhou, Xianming & Zhu, Hongquan, 2011. "Do ESOPs enhance firm performance? Evidence from China's reform experiment," Journal of Banking & Finance, Elsevier, vol. 35(6), pages 1541-1551, June.
    4. repec:jle:journl:170 is not listed on IDEAS
    5. Miao, Senlin & Wen, Fenghua & Zhang, Yun, 2022. "Industry tournament incentives and the speed of leverage adjustments: Evidence from China," International Review of Financial Analysis, Elsevier, vol. 83(C).

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Jianjun Miao, 2005. "Optimal Capital Structure and Industry Dynamics," Journal of Finance, American Finance Association, vol. 60(6), pages 2621-2659, December.
    2. Erwan Morellec & Boris Nikolov & Norman Schürhoff, 2012. "Corporate Governance and Capital Structure Dynamics," Journal of Finance, American Finance Association, vol. 67(3), pages 803-848, June.
    3. Hong Liu & Jianjun Miao, 2006. "Managerial Preferences, Corporate Governance, and Financial Structure," Boston University - Department of Economics - Working Papers Series WP2006-020, Boston University - Department of Economics.
    4. Strebulaev, Ilya A. & Whited, Toni M., 2012. "Dynamic Models and Structural Estimation in Corporate Finance," Foundations and Trends(R) in Finance, now publishers, vol. 6(1–2), pages 1-163, November.
    5. Erwan Morellec & Boris Nikolov & Norman Schürhoff, 2018. "Agency Conflicts around the World," The Review of Financial Studies, Society for Financial Studies, vol. 31(11), pages 4232-4287.
    6. Lambrecht, Bart M. & Myers, Stewart C., 2008. "Debt and managerial rents in a real-options model of the firm," Journal of Financial Economics, Elsevier, vol. 89(2), pages 209-231, August.
    7. Elkamhi, Redouane & Ericsson, Jan & Parsons, Christopher A., 2012. "The cost and timing of financial distress," Journal of Financial Economics, Elsevier, vol. 105(1), pages 62-81.
    8. Xu, Ruxing & Li, Shenghong, 2010. "Belief updating, debt pricing and financial decisions under asymmetric information," Research in International Business and Finance, Elsevier, vol. 24(2), pages 123-137, June.
    9. Martellini, Lionel & Milhau, Vincent & Tarelli, Andrea, 2018. "Capital structure decisions and the optimal design of corporate market debt prograams," Journal of Corporate Finance, Elsevier, vol. 49(C), pages 141-167.
    10. Lotfaliei, Babak, 2018. "The variance risk premium and capital structure," ESRB Working Paper Series 70, European Systemic Risk Board.
    11. Correia, Ricardo & Población, Javier, 2015. "A structural model with Explicit Distress," Journal of Banking & Finance, Elsevier, vol. 58(C), pages 112-130.
    12. Murray Carlson & Ali Lazrak, 2006. "Leverage Choice and Credit Spread Dynamics when Managers Risk Shift," 2006 Meeting Papers 193, Society for Economic Dynamics.
    13. Maclachlan, Iain C, 2007. "An empirical study of corporate bond pricing with unobserved capital structure dynamics," MPRA Paper 28416, University Library of Munich, Germany.
    14. Abel Elizalde, 2006. "Credit Risk Models II: Structural Models," Working Papers wp2006_0606, CEMFI.
    15. Hong-Yi Chen & Cheng Few Lee & Tzu Tai, 2020. "The Joint Determinants of Capital Structure and Stock Rate of Return: A LISREL Model Approach," World Scientific Book Chapters, in: Cheng Few Lee & John C Lee (ed.), HANDBOOK OF FINANCIAL ECONOMETRICS, MATHEMATICS, STATISTICS, AND MACHINE LEARNING, chapter 35, pages 1345-1397, World Scientific Publishing Co. Pte. Ltd..
    16. Liu, Liang-Chih & Dai, Tian-Shyr & Wang, Chuan-Ju, 2016. "Evaluating corporate bonds and analyzing claim holders’ decisions with complex debt structure," Journal of Banking & Finance, Elsevier, vol. 72(C), pages 151-174.
    17. Mahmoud Agha, 2013. "Leverage, executive incentives and corporate governance," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 53(1), pages 1-30, March.
    18. Marco Realdon, 2007. "Valuation of the Firm's Liabilities When Equity Holders Are Also Creditors," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 34(5‐6), pages 950-975, June.
    19. Strebulaev, Ilya A. & Yang, Baozhong, 2013. "The mystery of zero-leverage firms," Journal of Financial Economics, Elsevier, vol. 109(1), pages 1-23.
    20. Drobetz, Wolfgang & Pensa, Pascal & Wöhle, Claudia B., 2004. "Kapitalstrukturtheorie in Theorie und Praxis: Ergebnisse einer Fragebogenuntersuchung," Working papers 2004/09, Faculty of Business and Economics - University of Basel.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:jbfina:v:35:y:2011:i:1:p:36-50. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/jbf .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.