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Investment decisions with benefits of control

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Author Info
Poulsen, Thomas () (Department of Business Studies, Aarhus School of Business)
Abstract

This paper studies how large shareholders with bene…ts of control a¤ect …rms’ equity issue behavior and investment decisions. I introduce an explicit agency cost structure based on the large shareholder’s bene…ts of control. In a simple extension of Myers and Majluf [1984], I show that underinvestment is aggravated when there are bene…ts of being in control, and these bene…ts are diluted if equity is issued to …nance the investment project. I assume that large shareholders are constrained from further investments in their …rms, and that they maximize their own wealth, which includes the value of security bene…ts paid to all shareholders in proportion of ownership stake plus the value of private bene…ts from voting rights. Potential loss of control is calculated as the di¤erence in the largest shareholder’s voting power before and after a hypothetical equity issue. I use voting power as a representation of the large shareholders’expected private bene…ts. Using a large panel of U.S. data, I …nd that large shareholders’ concern with dilution of ownership and control cause …rms to issue less equity and to invest less. I also …nd that it has no signi…cant e¤ect whether new shares are issued to old shareholders or new shareholders.

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Paper provided by University of Aarhus, Aarhus School of Business, Department of Business Studies in its series Finance Research Group Working Papers with number F-2008-02.

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Length: 41 pages
Date of creation: 19 Mar 2008
Date of revision:
Handle: RePEc:hhb:aarbfi:2008-02

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Postal: The Aarhus School of Business, Fuglesangs Allé 4, DK-8210 Aarhus V, Denmark
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Related research
Keywords: Underinvestment; equity issue; ownership structure; influence; voting power; private benefits of control; potential loss of control;

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  1. Wu, Xueping & Wang, Zheng, 2005. "Equity financing in a Myers-Majluf framework with private benefits of control," Journal of Corporate Finance, Elsevier, vol. 11(5), pages 915-945, October. [Downloadable!] (restricted)
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  4. Malcolm Baker & Jeffrey Wurgler, 2002. "Market Timing and Capital Structure," Journal of Finance, American Finance Association, vol. 57(1), pages 1-32, 02. [Downloadable!] (restricted)
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  5. Jennifer Dlugosz & Rudiger Fahlenbrach & Paul Gompers & Andrew Metrick, 2004. "Large Blocks of Stock: Prevalence, Size, and Measurement," NBER Working Papers 10671, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Mitchell A. Petersen, 2005. "Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches," NBER Working Papers 11280, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  7. Simeon Djankov & Rafael LaPorta & Florencio Lopez-de-Silanes & Andrei Shleifer, 2005. "The Law and Economics of Self-Dealing," NBER Working Papers 11883, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Raghuram G. Rajan & Luigi Zingales, 1994. "What Do We Know About Capital Structure? Some Evidence from International Data," NBER Working Papers 4875, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  9. Fama, Eugene F, 1980. "Agency Problems and the Theory of the Firm," Journal of Political Economy, University of Chicago Press, vol. 88(2), pages 288-307, April. [Downloadable!] (restricted)
  10. Stulz, ReneM., 1988. "Managerial control of voting rights : Financing policies and the market for corporate control," Journal of Financial Economics, Elsevier, vol. 20(1-2), pages 25-54, January. [Downloadable!] (restricted)
  11. Harris, Milton & Raviv, Artur, 1991. " The Theory of Capital Structure," Journal of Finance, American Finance Association, vol. 46(1), pages 297-355, March. [Downloadable!] (restricted)
  12. Fama, Eugene F. & French, Kenneth R., 2005. "Financing decisions: who issues stock?," Journal of Financial Economics, Elsevier, vol. 76(3), pages 549-582, June. [Downloadable!] (restricted)
  13. Ivo Welch, 2004. "Capital Structure and Stock Returns," Journal of Political Economy, University of Chicago Press, vol. 112(1), pages 106-131, February. [Downloadable!] (restricted)
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