New evidence article in journal of empirical legal studies 74 january 2011 with 80 reads how we measure reads. On the other hand, if they do not take advantage of the tax shield provided by debt, they risk losing control through a hostile takeover. I develop a contingent claims model to examine the impacts of managerial entrenchment on capital structure and security valuation. Prior research has often taken the view that entrenched managers tend to avoid debt. They sample 237 fortune 500 companies over a 7year period, and. Managerial entrenchment, dividend policy and capital structure. From 1977 to 1996 these companies have made 110 issues of public and private seasoned equity and 7 public issues of straight debt. Consistent with the creditor alignment hypothesis, we find a positive relation between managerial entrenchment and leverage in diversified firms.
The capital structure is how a firm finances its overall operations and growth by using different sources of funds. Managerial entrenchment and capital structure decisions, new york university, leonard n. To be more specific, capital structure is a ratio of shortterm, longterm liabilities and equity. On the one hand, debt is costly for managers because they risk losing control in the event of default.
Berger is from the university of pennsylvania, and ofek and yermack are from new york university. Philip g berger, eli ofek and david yermack journal of finance, 1997, vol. Managerial entrenchment does not miti gate the agency problems of debt, since managerial decisions on milking properties and asset substitution could be driven. Capital structure is a blend of companys sources of finance and consists of several types of funding. The debt yield spread difference between c 5% and 9% is 257 bps for 0, and increases to 268 bps for 10%. The cost depends on the health of the companys balance sheeta triple aaa rated firm can borrow at extremely low rates vs. Managerial entrenchment and capital structure decision associations between the two. An empirical analysis of incremental capital structure decisions under managerial entrenchment. We study associations between managerial entrenchment and firms capital structures, with results generally suggesting that entrenched ceos seek to avoid debt. It facilitates the generation of numerous new results regarding corporate policies and managerial entrenchment. Other factors to consider in making capital structure.
Dynamic capital structure under managerial entrenchment by jeffrey zwiebel this paper develops a model in which managers voluntarily choose debt to credibly constrain their own future empirebuilding. The capital structure and investment decisions of the. Some of the chief factors affecting the choice of the capital structure are the. The goal of this research is comparable to that of berger, ofek and yermack 1997 in that both studies try to explain leverage variation from an agencybased view. This paper tests the influence of managerial entrenchment and capital structure decisions using. The effect of diversification shuangshuang ji department of finance belk college of business university of north carolina at charlotte 9201 university city blvd. We study associations between managerial entrenchment and firms capital structures, with results generally suggesting that entrenched ceos. Over time, this can affect capital structure decisions, which in turn affects the way in which shareholders and the managers opinions affect the way a company is run. Additionally, the model yields new testable implications for security design, and changes in debt and empirebuilding over managerial careers. We build a dynamic contingent claims model in which. New evidence prior research has often taken the view that entrenched managers tend to avoid debt. Managerial entrenchment, equity payout and capital structure. This paper tests the influence of managerial entrenchment and capital structure decisions using nepalese firms data and executives view.
This paper examines the impact of managerial entrenchment on corporate financing decisions. The analysis shows that managers selfinterested leverage choices deviate significantly from the optimal leverages that maximize firm values, partially explaining the suboptimal leverage ratios observed empirically graham 2007. Capital structure, executive compensation, and investment. Capital structure theory asks what is the optimal composition between debt and equity. Berger, eli ofek and david yermack new york university, leonard n. Research on managerial entrenchment and company capital. Contrary to this view, we find that firms with entrenched managers, as measured by the gompers et al. The capital structure of a rm should then be determined not only by real market frictions, such as taxes, bankruptcy costs or re nancing costs, but also by the degree of managerial entrenchment. Aswath damodaran 3 the objective in decision making n in traditional corporate finance, the objective in decision making is to maximize the value of the firm. The aim of the paper is, hence, to ascertain the pattern of financing decisions of overconfident managers and identify the relevant capital structure theory tradeoff or pecking order theory. Staggered boards, managerial entrenchment, and dividend. Impact of capital structure choice on investment decisions.
It is the employment of an asset source of finance for which. Throughout, the book emphasizes how a sound capital structure. The capital structure is the way that the company chooses to fund its own. There has already been much research to the factors that influence decisions concerning the capital structure. In addition to a consideration of tax effects, financial distress costs, agency costs, the business risk facing the firm, ebiteps analysis, and cash insolvency analysis, there are additional factors normally considered as a firm makes its capital structure decisions. The paper explores a vast body of literature in articulating critical issues in capital structure decision. The surprising conclusion i draw is that managerial traits can enhance. I find a positive relationship between managerial entrenchment, measured as the amount of antitakeover provisions in place, and financial leverage. At the same time, how to solve the problem of agency conflict between. This paper contributes to our understanding of capital structure in several ways. Managerial entrenchment, managers own characteristics, incentives for managers, capital structure.
Capital structure and corporate financing decisions provides an indepth examination of critical capital structure topics, including discussions of basic capital structure components, key theories and practices, and practical application in an increasingly complex corporate world. Capital structure decisions in financial management free download as powerpoint presentation. The relative proportion of various sources of funds. Under the capital structure, decision the proportion of longterm sources of capital is determined. However, it shows that both the magnitude and the combination of managerial biases determine preferences regarding debt vs.
The empirical evidence seems reasonably consistent with some versions of the tradeoff theory of capital structure. Besides that the dutch governance structure is characterized by the presence of large shareholders. In a crosssectional analysis, we find that leverage levels are lower when ceos do not face pressure from either ownership and compensation incentives or active monitoring. Pdf dynamic capital structure under managerial entrenchment. Introduction capital structure refers to the different options used by a firm in financing its assets bhaduri, 2002. Ofek, eli, 1994, efficiency gains in unsuccessful management buyouts, journal of finance 49, 637654. For this reason a discrepancy exists between managerial decisions and shareholder reactions.
As such, managerial traits theory does not part from traditional capital structure theories. Firms capital structure decisions and product market. Managerial entrenchment and capital structure decision. We study associations between managerial entrenchment and firms capital structures, with results generally suggesting that entrenched ceos seek to. The choice of financing mode and debtequity ratio is the core of capital structure decision.
Staggered boards, managerial entrenchment, and dividend policy article in journal of financial services research 361. Most favourable proportion determines the optimum capital structure. A companys capital structure is arguably one of its most important choices. This paper empirically examines how diversification influences the relation between corporate governance and capital structure. There are associations between managerial entrenchment and capital structure decisions which mostly result on the fact that ceos are reluctant to go into debt when funding an investment. In a crosssectional analysis, we find that leverage levels are lower when ceos do not face pressure from either ownership and. Research on managerial entrenchment and company capital structure. Dynamic capital structure under managerial entrenchment. Four major theories of corporate financing have been developed, according to myers 2002. We build a dynamic contingent claims model in which financing policy results from a tradeoff between. Pdf this paper examines the impact of managerial entrenchment on corporate financing decisions. If this is the first time you use this feature, you will be asked to authorise cambridge core to connect with your account. Capital structure hao wang faculty of management, mcgill universityy november 16, 2006 abstract this article develops a contingentclaims model to examine the impact of managerial entrenchment on corporate policies and security valuation.
Capital structure decisions in financial management capital. Second, it is likely that patterns of corporate financing decisions have changed over the decades. The model emphasizes the role that managerial agency issues play in determining both a rms dividend. We examine the influence of managerial incentives, traditional managerial monitoring mechanisms and managerial entrenchment on the capital structure of real estate investment trusts reits. First, the modiglianimiller theory 1958, alleging that in complete markets investment decisions do not affect the capital structure. From a technical perspective, the capital structure is defined as the careful balance between equity and debt that a business uses to finance its assets, daytoday operations, and future growth.
This situation makes the case for capital structure decisions of dutch companies particularly interesting. The authors study associations between managerial entrenchment and firms capital structures, with results generally suggesting that entrenched ceos seek to avoid debt. Chapter iii concepts and theories of capital structure and profitability. The debt capital in a companys capital structure refers to borrowed money that is at work in the business. Faleye, 2009 and shareholder monitoring gillan and starks, 2000. Third, we take the model to the data and provide rmspeci c estimates of the degree of managerial entrenchment.
Managerial entrenchment and capital structure decisions. Biased managers higher debt levels restrain them from diverting funds, which increases firm value by reducing this managershareholder conflict. Abstract under the modern enterprise system, it is an inevitable problem for the management to act according to their own interests when making decisions. The analysis shows that managers selfinterested leverage choices deviate significantly from the optimal leverages that maximize firm values, partially explaining the suboptimal leverage ratios observed empirically graham, 2000. A dynamic perspective volume 50 issue 5 xin chang, hong feng zhang. Hence, the issue of the lenders own capital structure is ignored. Arko, ownership structure, corporate governance and capital structure decisions of firms, studies in economics and finance, 26, 4, 246, 2009. Vishty, management entrenchment divisions and use above market discount rates in the capital budgeting process. Plenty of companies with sliding stock prices and shrinking market shares have been unable to dislodge powerful ceos whose best days are. Furthermore, the capital structure of a firm, which is a mix of debt and equity that is used by a firm, and the investment decision are important to enhance its operation. In the burgeoning literature on small firm financing, the problem of underidentification in respect to the supply of, and demand for, capital has not been fully resolved. Key factors influencing capital structure decision and.
There are associations between managerial entrenchment and capital structure decisions which mostly result on the fact that ceos are reluctant to debt when funding an investment. Managerial traits and capital structure decisions request pdf. Firms capital structure, page 1 firms capital structure decisions and product market competition. Request pdf managerial entrenchment and capital structure. Managerial entrenchment and capital structure decisions 1415 investigate whether large changes in entrenchmentrelated governance variables lead to major changes in leverage. Entrenchment versus efficiency, working paper, graduate school of business, university of chicago. Second, we derive implications relating managerial entrenchment to the rms target leverage and the pace and size of capital structure changes. The practical implications of investigating capital structures and the strength of capital structure determinants on listed smes in sweden is to increase understanding of what factors companies value most with regard to capital structure decisions. Empirical researchers have used an array of methods to examine the relation between managerial entrenchment and nancing decisions.
A majority of earlier studies show that firm leverage is negatively associated with the degree of entrenchment of managers. Managerial traits enrich tradeoff theory by allowing personal characteristics to have an impact on capital structure decisions. A policy of capital structure coordinated with dividends follows naturally, as do implications for the level, frequency, and maturity structure of debt as a function of outside investment opportunities. Every company needs capital to support its operations. Pdf an empirical analysis of incremental capital structure. Capital structure and corporate financing decisions. An empirical analysis of incremental capital structure. From a tactical perspective however, it influences everything from the firms risk profile, how easy. This paper examines the relationship between managerial entrenchment and capital structure using a sample of 1,929 us firms over the period of 1990 to 2006. Save to my profile managerial entrenchment and capital structure decisions. Dynamically consistent capital structure is derived as the optimal response in each period of partially entrenched managers. First, starting with a long list of factors from the prior literature, we examine which factors are reliably signed, and reliably important, for predicting leverage. A higher coupon rate implies a greater likelihood of default and a higher bond yield spread. Stern school finance department working paper seires from new york university, leonard n.
Nov 11, 2008 we test the prediction that leverage is inversely associated with managerial entrenchment. It is the way a firm finances its assets through some combination of equity, debt, or hybrid securities. We seek to answer this question by examining 428 mergers 19621982 and. Dynamically consistent capital structure is derived as the optimal response in each period of partially entrenched managers tradingoff empirebuilding ambitions with the need to ensure sufficient efficiency to prevent control challenges.
Capital structure is essentially concerned with how the firm decides to divide its cash flows into two broad components, a fixed component that is earmarked to meet the obligations toward debt capital and a residual component that belongs to equity shareholdersp. Managerial entrenchment and capital structure decisions 1417 jensen and meckling 1976 and other autbors bave identified managerial equity ownership as an important influence upon firm value, and we therefore include in our model the ceos direct stock ownership, measured as a per centage of common equity. Managerial entrenchment can reach all the way to the csuite. That happens to be the need of the company because eps happens to be the maximum on it. Novaes, walter, and luigi zingales, 1995, capital structure choice when managers are in control.
Capital structure is a firms mix of methods for financing investments and its overall operations and growth. Mauer department of finance belk college of business. Classic models of the free cash flow problem jensen 1986, stulz 1990, and hart and moore 1995 argue that the greater use of debt reduces the agency cost of equity, since it constrains managers from pursuing inefficient investment. Research article capital structure and investment decision. We find that leverage levels are positively related to ceo stock ownership and ceo stock option holdings, and negatively related to ceo tenure and board. The role that the control variables play in determining capital structure and debt maturityhas been studied previously by barclay and smith 1995, faulkender and petersen 2006,guedes and opler 1996, johnson 2003, and rajan and zingales 1995. This paper develops a model in which managers voluntarily choose debt to credibly constrain their own future empirebuilding. Apr 18, 2012 managerial entrenchment and capital structure decisions. Ceo entrenchment and corporate liquidity management request pdf.
Jul 30, 2019 one of the biggest threats to longterm success is managerial entrenchment, which occurs when corporate leaders put their own selfinterests ahead of the companys goals. In an attempt to progress this issue, the current paper looks at some of the issues influencing the demand for finance in small firms which are ownermanaged. The next section describes our model, and section 3 applies it to a range of. Stern school finance department working paper seires 9614, new york university, leonard n. We examine leverage levels and yeartoyear changes for several hundred firms between 1984 and 1991. We study incremental capital structure decisions of dutch companies. Managerial entrenchment and capital structure decisions 1415 investigate whether large changes in entrenchment related governance variables lead to major changes in leverage. Apr 18, 2012 we study associations between managerial entrenchment and firms capital structures, with results generally suggesting that entrenched ceos seek to avoid debt.
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