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Is Leverage Effective in Increasing Performance Under Managerial Moral Hazard?

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Author Info

  • Calcagno, R.

    (Tilburg University, Center for Economic Research)

Abstract

We consider a model in which the principal-agent relation between inside shareholders and the management affects the firm value.We study the effect of financing the project with risky debt in changing the incentive for a risk-neutral shareholder (the principal) to implement the project-value maximizing contract.We show the conditions under which leverage generates agency costs in terms of an ex-ante reduction of the firm value.The result also implies that the optimal remuneration structure includes "low-incentive" bonus when the firm is highly leveraged.This inefficiency does not arise when the the agent is paid with shares of the firm.We can then conclude that the use of debt is effective as a commitment device to implement higher operative performance only if it is accompanied with a compensation policy based on shares remuneration.

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Bibliographic Info

Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 2000-101.

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Date of creation: 2000
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Handle: RePEc:dgr:kubcen:2000101

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Related research

Keywords: corporate performance; management; moral hazard; capital structure; incentives; agency theory;

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References

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  12. Innes, Robert D., 1990. "Limited liability and incentive contracting with ex-ante action choices," Journal of Economic Theory, Elsevier, vol. 52(1), pages 45-67, October.
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  16. Denis, David J., 1994. "Organizational form and the consequences of highly leveraged transactions: Kroger's recapitalization and Safeway's LBO," Journal of Financial Economics, Elsevier, vol. 36(2), pages 193-224, October.
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Cited by:
  1. Jain, Neelam, 2006. "Debt, managerial compensation and learning," European Economic Review, Elsevier, vol. 50(2), pages 377-399, February.
  2. André SCHMITT & Sandrine SPAETER, 2002. "Improving the Prevention of Environmental Risks with Convertible Bonds," Working Papers of BETA 2002-14, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.

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