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Endogenous Managerial Incentives and the Optimal Combination of Debt and Dividend Commitments

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  • Alan V. Douglas

Abstract

This paper studies the optimal combination of debt and dividend commitments in an agency model of the firm. Financial policy is relevant because ex-post information asymmetryrequires managerial rewards to depend on the ability to meet financial commitments. If perquisite or inside information problems exist in isolation, debt-based incentives as assumed inprevious studies result endogenously. If the problems exist simultaneously, dividends can beoptimal even when they appear excessively costly as a signal and unduly lenient as a disciplining device. The reason is that the set of dynamically consistent rewards increases when debt commitments are augmented with dividend commitments, and a larger set of ex-post rewards is more valuable as ex-ante decisions become more complex. JEL classification codes: G30, D82

Suggested Citation

  • Alan V. Douglas, 2002. "Endogenous Managerial Incentives and the Optimal Combination of Debt and Dividend Commitments," Review of Finance, European Finance Association, vol. 6(1), pages 63-99.
    • Handle: RePEc:oup:revfin:v:6:y:2002:i:1:p:63-99.
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    File URL: http://hdl.handle.net/10.1023/A:1015039007234
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    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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