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Capital Structure Choice When Managers Are in Control: Entrenchment versus Efficiency

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  • Walter Novaes

    (Pontifical Catholic University (PUC-Rio))

Abstract

In the free-cash-flow theory, shareholders use debt to discipline managers and maximize firm value. In contrast, managerial models assume that, without a takeover threat, managers will not lever up to constrain themselves. This article demonstrates that a takeover threat is unlikely to reconcile these two theories. In particular, with low takeover costs, target managers may overlever. Yet, both theories are consistent with recent papers that document a negative correlation between leverage and takeover costs. I propose a test of the two theories by showing that, in the value-maximizing approach, antitakeover amendments reduce the sensitivity of leverage to entrenchment-related variables.

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Bibliographic Info

Article provided by University of Chicago Press in its journal Journal of Business.

Volume (Year): 76 (2003)
Issue (Month): 1 (January)
Pages: 49-82

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Handle: RePEc:ucp:jnlbus:v:76:y:2003:i:1:p:49-82

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  8. Israel, Ronen, 1991. " Capital Structure and the Market for Corporate Control: The Defensive Role of Debt Financing," Journal of Finance, American Finance Association, American Finance Association, vol. 46(4), pages 1391-1409, September.
  9. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, American Economic Association, vol. 76(2), pages 323-29, May.
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  13. Myers, Stewart C., 1984. "Capital structure puzzle," Working papers, Massachusetts Institute of Technology (MIT), Sloan School of Management 1548-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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Cited by:
  1. Isagawa, Nobuyuki, 2000. "Convertible debt: an effective financial instrument to control managerial opportunism," Review of Financial Economics, Elsevier, Elsevier, vol. 9(1), pages 15-26.
  2. Jayati Sarkar & Subrata Sarkar, 2005. "Debt and corporate governance in emerging economies: Evidence from India," Indira Gandhi Institute of Development Research, Mumbai Working Papers 2005-007, Indira Gandhi Institute of Development Research, Mumbai, India.
  3. Zingales, Luigi, 1998. "Corporate Governance," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1806, C.E.P.R. Discussion Papers.
  4. Jong, A. de, 2001. "The Disciplining Role of Leverage in Dutch Firms," Discussion Paper, Tilburg University, Center for Economic Research 2001-48, Tilburg University, Center for Economic Research.
  5. Preece, Dianna C. & Mullineaux, Donald J. & Filbeck, Greg & Dennis, Steven A., 2004. "Agency theory and the House bank affair," Review of Financial Economics, Elsevier, Elsevier, vol. 13(3), pages 259-267.
  6. Doukas, John A. & Pantzalis, Christos, 2003. "Geographic diversification and agency costs of debt of multinational firms," Journal of Corporate Finance, Elsevier, Elsevier, vol. 9(1), pages 59-92, January.
  7. Arturo Bris & Salvatore Cantale, 1998. "Bank Capital Requirements and Managerial Self-Interest," Yale School of Management Working Papers, Yale School of Management ysm105, Yale School of Management, revised 01 Aug 2000.
  8. Nigel Driffield & Vidya Mahambare & Sarmistha Pal, 2004. "Dynamic Adjustment of Corporate Leverage: Is there a lesson to learn from the Recent Asian Crisis?," Finance, EconWPA 0405007, EconWPA.
  9. Joseph P. Hughes & William W. Lang & Choon-Geol Moon & Michael S. Pagano, 2004. "Managerial Incentives and the Efficiency of Capital Structure in U.S. Commercial Banking," Departmental Working Papers, Rutgers University, Department of Economics 200401, Rutgers University, Department of Economics.
  10. Luis H Gutiérrez & Carlos Pombo, 2005. "Corporate Valuation and Governance: Evidence from Colombia," BORRADORES DE INVESTIGACIÓN, UNIVERSIDAD DEL ROSARIO 002203, UNIVERSIDAD DEL ROSARIO.
  11. Isagawa, Nobuyuki, 2002. "Callable convertible debt under managerial entrenchment," Journal of Corporate Finance, Elsevier, Elsevier, vol. 8(3), pages 255-270, July.
  12. Takanori Tanaka, 2009. "Managerial Entrenchment and Corporate Bond Financing: Evidence from Japan," Discussion Papers in Economics and Business 09-10, Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP).
  13. Joseph P. Hughes & William W. Lang & Choo-Geol Moon & Michael S. Pagano, 2001. "Managerial incentives and the efficiency of capital structure," Proceedings, Federal Reserve Bank of Chicago 713, Federal Reserve Bank of Chicago.
  14. Luis H. Gutiérrez & Carlos Pombo, 2005. "Valuación y gobierno corporativo: elementos de juicio de Colombia," Research Department Publications, Inter-American Development Bank, Research Department 3217, Inter-American Development Bank, Research Department.
  15. Chen, Andrew & Hwang, Yuhchang & Shao, Benjamin, 2005. "Measurement and sources of overall and input inefficiencies: Evidences and implications in hospital services," European Journal of Operational Research, Elsevier, Elsevier, vol. 161(2), pages 447-468, March.
  16. Aivazian, Varouj A. & Ge, Ying & Qiu, Jiaping, 2005. "The impact of leverage on firm investment: Canadian evidence," Journal of Corporate Finance, Elsevier, Elsevier, vol. 11(1-2), pages 277-291, March.
  17. Howell, Jann C. & Stover, Roger D., 2002. "How much do governance and managerial behavior matter in investment decisions? Evidence from failed thrift auctions," Journal of Corporate Finance, Elsevier, Elsevier, vol. 8(3), pages 195-211, July.
  18. Armando Gomes & Gordon Phillips, 2005. "Why Do Public Firms Issue Private and Public Securities?," NBER Working Papers 11294, National Bureau of Economic Research, Inc.

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