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The Design of Internal Control and Capital Structure

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  • Berkovitch, Elazar
  • Israel, Ronen
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    Abstract

    We study the design of internal control and capital structure. We pose the question, When is control allocated only to shareholders and when is it allocated to other stakeholders, such as debtholders, or the management team? We show that shareholders (debtholders) get control when the firm's cash flow is relatively sensitive (insensitive) to managerial effort. Our theory implies that the signs of the correlations between endogenous variables when shareholders have absolute control are reversed when debtholders have veto power. In particular, debt level and firm value are negatively (positively) correlated when debtholders have veto power (shareholders have absolute control). Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

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    Bibliographic Info

    Article provided by Society for Financial Studies in its journal Review of Financial Studies.

    Volume (Year): 9 (1996)
    Issue (Month): 1 ()
    Pages: 209-40

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    Handle: RePEc:oup:rfinst:v:9:y:1996:i:1:p:209-40

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    Cited by:
    1. Matthew C. Clayton & Jay C. Hartzell & Joshua Rosenberg, 2005. "The Impact of CEO Turnover on Equity Volatility," The Journal of Business, University of Chicago Press, vol. 78(5), pages 1779-1808, September.
    2. Akbel, Basak & Schnitzer, Monika, 2010. "Creditor Rights and Debt Allocation within Multinationals," CEPR Discussion Papers 7958, C.E.P.R. Discussion Papers.
    3. Grinstein, Yaniv, 2006. "The disciplinary role of debt and equity contracts: Theory and tests," Journal of Financial Intermediation, Elsevier, vol. 15(4), pages 419-443, October.
    4. Gary Gorton & Bruce D. Grundy, 1996. "Executive Compensation and the Optimality of Managerial Entrenchment," NBER Working Papers 5779, National Bureau of Economic Research, Inc.
    5. Choe, Chongwoo, 2001. "Leverage, Volatility and Executive Stock Options," Discussion Paper Series a420, Institute of Economic Research, Hitotsubashi University.
    6. David R. Skeie, 2007. "Vesting and control in venture capital contracts," Staff Reports 297, Federal Reserve Bank of New York.
    7. Douglas, Alan V. S., 2002. "Capital structure and the control of managerial incentives," Journal of Corporate Finance, Elsevier, vol. 8(4), pages 287-311, October.
    8. Markus Lehmann, 2004. "Voluntary Environmental Agreements and Competition Policy," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 28(4), pages 435-449, August.
    9. Anil Arya & Jonathan Glover, 2006. "The Use of Debt to Prevent Short-Term Managerial Exploitation," Annals of Finance, Springer, vol. 2(4), pages 357-368, October.
    10. Li, Wei-Xuan & Chen, Clara Chia-Sheng & French, Joseph J., 2012. "The relationship between liquidity, corporate governance, and firm valuation: Evidence from Russia," Emerging Markets Review, Elsevier, vol. 13(4), pages 465-477.
    11. Maug, Ernst, 1997. "Boards of directors and capital structure: Alternative forms of corporate restructuring," Journal of Corporate Finance, Elsevier, vol. 3(2), pages 113-139, April.

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