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Dividends and Debt with Managerial Agency and Lender Holdup

  • George Kanatas

    ()

    (Jones Graduate School of Administration, Rice University, 6100 South Main Street, Houston, Texas 77005-1892)

  • Jianping Qi

    ()

    (College of Business Administration, University of South Florida, 4202 East Fowler Avenue, BSN 3403, Tampa, Florida 33620-5500)

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    A well-known view in the literature is that if management is more concerned with the firm's survival than with profitability, it is efficient to use a levered capital structure and thereby transfer the liquidation decision to lenders. Our paper extends this idea to a setting where lenders behave opportunistically when they control the liquidation decision. We show that in this situation, an optimal mix of debt and dividends can mitigate the twin moral hazard problems of the manager and the lender. Given an otherwise optimal capital structure, initiating a dividend policy increases firm value, lowers debt payments, but raises total cash disbursementsÔinterest and dividendsÔto investors. Numerous other empirical implications of the model are also discussed.

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    File URL: http://dx.doi.org/10.1287/mnsc.1030.0183
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    Article provided by INFORMS in its journal Management Science.

    Volume (Year): 50 (2004)
    Issue (Month): 9 (September)
    Pages: 1249-1260

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    Handle: RePEc:inm:ormnsc:v:50:y:2004:i:9:p:1249-1260
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    1. Harris, Milton & Raviv, Artur, 1990. " Capital Structure and the Informational Role of Debt," Journal of Finance, American Finance Association, vol. 45(2), pages 321-49, June.
    2. Chang, Chun, 1993. "Payout Policy, Capital Structure, and Compensation Contracts When Managers Value Control," Review of Financial Studies, Society for Financial Studies, vol. 6(4), pages 911-33.
    3. Woolridge, J Randall, 1983. " Dividend Changes and Security Prices," Journal of Finance, American Finance Association, vol. 38(5), pages 1607-15, December.
    4. Berlin, Mitchell & Loeys, Jan, 1988. " Bond Covenants and Delegated Monitoring," Journal of Finance, American Finance Association, vol. 43(2), pages 397-412, June.
    5. Steven A. Sharpe, 1989. "Asymmetric information, bank lending, and implicit contracts: a stylized model of customer relationships," Finance and Economics Discussion Series 70, Board of Governors of the Federal Reserve System (U.S.).
    6. Kanatas, George & Qi, Jianping, 2001. "Imperfect Competition, Agency, and Financing Decisions," The Journal of Business, University of Chicago Press, vol. 74(2), pages 307-38, April.
    7. Sanford J. Grossman & Oliver D. Hart, 1982. "Corporate Financial Structure and Managerial Incentives," NBER Chapters, in: The Economics of Information and Uncertainty, pages 107-140 National Bureau of Economic Research, Inc.
    8. Easterbrook, Frank H, 1984. "Two Agency-Cost Explanations of Dividends," American Economic Review, American Economic Association, vol. 74(4), pages 650-59, September.
    9. Philippe Aghion & Patrick Bolton, 1992. "An Incomplete Contracts Approach to Financial Contracting," Review of Economic Studies, Oxford University Press, vol. 59(3), pages 473-494.
    10. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-29, May.
    11. Rajan, Raghuram & Winton, Andrew, 1995. " Covenants and Collateral as Incentives to Monitor," Journal of Finance, American Finance Association, vol. 50(4), pages 1113-46, September.
    12. Gustavo Grullon & Roni Michaely & Bhaskaran Swaminathan, 2002. "Are Dividend Changes a Sign of Firm Maturity?," The Journal of Business, University of Chicago Press, vol. 75(3), pages 387-424, July.
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