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Managerial discretion and optimal financing policies with cash flow uncertainty

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  • Alessandro Fiaschi

Abstract

Building on the work of Stulz (1990), this paper analyzes the impact of managerial discretion on optimal leverage within an agency cost model of corporate financing. Under the assumption that stockholders do not know with certainty the mean of the cash flow distribution, we argue that leverage fails to control for the amount of cash the manager can misappropriate in personal projects. We develop a model of a firm’s value maximization problem that predicts that as expected earnings uncertainty increases the firm will decrease its optimal level of borrowing. In a second part, we test this proposition on a panel of non–financial UK firms, by investigating the determinants of firms’ performance and allowing for endogeneity of capital structure decisions. The estimates confirm that earnings uncertainty, as measured by the volatility in monthly consensus forecasts of individual companies’ earnings per share, negatively affects corporate leverage. Furthermore, new empirical support is found to the agency cost view that corporate performance is positively correlated with leverage when poorly managed firms are selected.

Suggested Citation

  • Alessandro Fiaschi, 2009. "Managerial discretion and optimal financing policies with cash flow uncertainty," Working Papers 3, Doctoral School of Economics, Sapienza University of Rome.
    • Handle: RePEc:dsc:wpaper:3
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    File URL: http://phdschool-economics.dse.uniroma1.it/website/workingpapers/fiaschiwp3.pdf
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    More about this item

    JEL classification:

    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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