- Managerial autonomy, allocation of control rights and optimal capital structure
- Number of pages
- Amsterdam: Faculteit Economie en Bedrijfskunde
- Document type
- Working paper
- Interfacultary Research Institutes
Faculty of Economics and Business (FEB)
- Amsterdam Center for Law & Economics (ACLE)
Amsterdam Business School Research Institute (ABS-RI)
We examine how the firm's initial owners design the control rights of bondholders and new shareholders and the manner in which these control rights interact with the manager's choice of the firm's capital structure. Even though the manager's objective is to maximize the terminal wealth of the initial shareholders, and the manager and initial shareholders have congruent beliefs, new investors may have different beliefs, creating the potential for manager-investor disagreement over project choice. The manager values his project choice autonomy in the face of disagreement with investors because greater autonomy enhances his ability to maximize shareholder wealth. This approach generates a managerial preference for "soft" claims—those that give him the most autonomy—in sharp contrast to agency models that predict an ex ante preference for "hard" claims that limit the manager's ex post discretion. The model generates a dynamic "pecking order" consisting of cash, equity and debt that shifts based on the firm's stock price and value of assets in place. The results help explain why firms issue equity when stock prices are high and why investors buy such stock, as well as why firms' leverage ratios drift with stock returns without countervailing actions by firms. Numerous additional predictions are generated, including those related to cash hoarding within the firm and the use of debt in the absence of taxes, signaling considerations and agency problems between managers and shareholders.
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