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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.

Suggested Citation

  • Walter Novaes, 2003. "Capital Structure Choice When Managers Are in Control: Entrenchment versus Efficiency," The Journal of Business, University of Chicago Press, vol. 76(1), pages 49-82, January.
    • Handle: RePEc:ucp:jnlbus:v:76:y:2003:i:1:p:49-82
    DOI: 10.1086/344113
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