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Entrepreneurial Finance and the Creation of Value: Agency Costs vs. Cognitive Value

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  • Peter Wirtz

    (Laboratoire de Recherche Magellan - UJML - Université Jean Moulin - Lyon 3 - Université de Lyon - Institut d'Administration des Entreprises (IAE) - Lyon)

Abstract

The O.M. Scott case study published in 1989 in the Journal of Financial Economics has come to be a classic in illustrating the plausibility of some fundamental concepts that underpin mainstream models of the efficiency attributes of capital structure in modern corporate finance. In these models, high leverage traditionally appears as a strong incentive to refrain from sub-optimal investment behavior by self-interested managers. Thus reducing managerial agency cost has been considered as an essential driver of enhanced value in much of financial modeling. The present chapter attempts a somewhat different, albeit complementary, mainly resource based interpretation of the very rich empirical material contained in Baker and Wruck (1989). In fact, a close reading of the case suggests that the observed significant increase in operating performance post-LBO was to a great extent the consequence of the yet unexplored cognitive changes implied by switching dominant shareholders. Namely, we find that value at O.M. Scott was essentially increased by (1) a significant reduction in what may be termed cognitive agency costs while (2) the new dominant shareholder, a private equity firm, contributed substantial cognitive value by stimulating and advising a dynamic learning process leading to enforced entrepreneurial and managerial capabilities, especially with respect to more effective routines of cash management. Beyond their observed plausibility in the context of leveraged buyouts, one may hypothesize that concepts of cognitive value and cognitive cost are relevant to entrepreneurial finance in general, especially in the case of funding highly innovative young ventures.

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  • Peter Wirtz, 2015. "Entrepreneurial Finance and the Creation of Value: Agency Costs vs. Cognitive Value," Post-Print hal-01178314, HAL.
    • Handle: RePEc:hal:journl:hal-01178314
    Note: View the original document on HAL open archive server: https://univ-lyon3.hal.science/hal-01178314
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    References listed on IDEAS

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