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A model of dynamic compensation and capital structure

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  • He, Zhiguo
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    Abstract

    This paper studies the optimal compensation problem between shareholders and the agent in the Leland (1994) capital structure model, and finds that the debt-overhang effect on the endogenous managerial incentives lowers the optimal leverage. Consistent with data, our model delivers a negative relation between pay-performance sensitivity and firm size, and the interaction between debt-overhang and agency issue leads smaller firms to take less leverage relative to their larger peers. During financial distress, a firm's cash flow becomes more sensitive to underlying performance shocks due to debt-overhang. The implications on credit spreads and debt covenants are also considered.

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    File URL: http://www.sciencedirect.com/science/article/B6VBX-5236RGR-1/2/a093c910ea2b76aff01caa0e8c83d167
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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Financial Economics.

    Volume (Year): 100 (2011)
    Issue (Month): 2 (May)
    Pages: 351-366

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    Handle: RePEc:eee:jfinec:v:100:y:2011:i:2:p:351-366

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    Web page: http://www.elsevier.com/locate/inca/505576

    Related research

    Keywords: Continuous-time contracting Capital structure CARA (exponential) preference Firm growth Size-heterogeneity Pay-performance sensitivity;

    References

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    Cited by:
    1. Jianfeng Yu & Bin Wei & Zhiguo He, 2012. "Optimal Long-term Contracting with Learning," 2012 Meeting Papers 221, Society for Economic Dynamics.
    2. Douglas W. Diamond & Zhiguo He, 2012. "A Theory of Debt Maturity: The Long and Short of Debt Overhang," NBER Working Papers 18160, National Bureau of Economic Research, Inc.
    3. Hiroshi Osano & Keiichi Hori, 2013. "Managerial Incentives and the Role of Advisors in the Continuous-Time Agency Model," KIER Working Papers 863, Kyoto University, Institute of Economic Research.

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