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A model of dynamic compensation and capital structure

  • He, Zhiguo
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    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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    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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