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Capital Structure Choice when Managers are in Control: Entrenchment versus Efficiency

  • Walter Novaes
  • Luigi Zingales

Recent capital structure theories have emphasized the role of debt in minimizing the agency costs that arise from the separation between ownership and control. In this paper we argue that capital structure choices themselves are affected by the same agency problem. We show that, in general, the shareholders' and the manager's capital structure choices differ not only in their levels, but also in their sensitivities to the cost of financial distress and taxes. We argue that only the managerial perspective can explain why firms are generally reluctant to issue equity, why they issue it only following a stock price run-up, and why Corporate America recently deleveraged under the same tax system that supposedly generated the increase in leverage in the 1980s.

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File URL: http://www.nber.org/papers/w5384.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5384.

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Date of creation: Dec 1995
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Publication status: published as Walter Novaes, 2003. "Capital Structure Choice When Managers Are in Control: Entrenchment versus Efficiency," Journal of Business, University of Chicago Press, vol. 76(1), pages 49-82, January.
Handle: RePEc:nbr:nberwo:5384
Note: CF
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  1. Myers, Stewart C, 1984. " The Capital Structure Puzzle," Journal of Finance, American Finance Association, vol. 39(3), pages 575-92, July.
  2. Jensen, Michael C & Murphy, Kevin J, 1990. "Performance Pay and Top-Management Incentives," Journal of Political Economy, University of Chicago Press, vol. 98(2), pages 225-64, April.
  3. Israel, Ronen, 1991. " Capital Structure and the Market for Corporate Control: The Defensive Role of Debt Financing," Journal of Finance, American Finance Association, vol. 46(4), pages 1391-1409, September.
  4. Stulz, ReneM., 1990. "Managerial discretion and optimal financing policies," Journal of Financial Economics, Elsevier, vol. 26(1), pages 3-27, July.
  5. 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.
  6. Stewart C. Myers, 1984. "Capital Structure Puzzle," NBER Working Papers 1393, National Bureau of Economic Research, Inc.
  7. Harris, Milton & Raviv, Artur, 1988. "Corporate control contests and capital structure," Journal of Financial Economics, Elsevier, vol. 20(1-2), pages 55-86, January.
  8. Harris, Milton & Raviv, Artur, 1989. "The design of securities," Journal of Financial Economics, Elsevier, vol. 24(2), pages 255-287.
  9. Jeffrey MacKie-Mason, 1988. "Do Taxes Affect Corporate Financing Decisions?," NBER Working Papers 2632, National Bureau of Economic Research, Inc.
  10. Myers, Stewart C., 1984. "Capital structure puzzle," Working papers 1548-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  11. Hart, Oliver & Moore, John, 1995. "Debt and Seniority: An Analysis of the Role of Hard Claims in Constraining Management," American Economic Review, American Economic Association, vol. 85(3), pages 567-85, June.
  12. 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.
  13. 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.
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