Managerial Preferences, Corporate Governance, and Financial Structure

Abstract:     
Conflicts of interest between insiders (e.g, controlling shareholders) and outsiders (e.g., minority shareholders) are central to the analysis of modern corporation. In an integrated continuous-time contingent claims framework with imperfect corporate governance, we examine a controlling shareholder's optimal choice of capital structure, ownership concentration, private benefit diversion, consumption, and financial market investment. We derive solutions in explicit parametric forms up to numerical integrations. In addition to generating implications consistent with existing empirical evidence, we also show that managerial preference characteristics (such as risk aversion and impatience), corporate governance, and financial market are important determinants of equity value, credit spread, agency costs, capital structure, and ownership concentration. Our model produces many novel empirically testable predictions. For example, it implies that a more risk averse or a less impatient entrepreneur issues less debt and more equity, and that stronger corporate governance leads to higher equity value, lower leverage, less ownership concentration, and lower credit spread. In addition, it also suggests that as the Sharpe ratio in the financial market increases, firm leverage ratio, agency costs, and credit spread all increase.

Number of Pages in PDF File: 46

Keywords: Managerial/entrepreneurial characteristics, ownership and capital structure, private benefits of control, corporate governance

JEL Classification: D11, D91, G11, C61

working papers series