Managerial Compensation and Capital Structure Under Asymmetric Information

Abstract:     
We consider project financing when the project quality is private information of the manager and, given its inherent quality, the project viability depends on the manager exerting unobservable effort. We show that capital structure matters even though managerial contracts are optimally designed. We also provide an explanation of why good firms issue both debt and underpriced equity (even if the bankruptcy and agency costs of debt are zero). Finally, we show that the optimal financial contract can be implemented by a combination of debt and equity. Our results have a number of testable implications.

Number of Pages in PDF File: 27

Keywords: Asymmetric Information, Capital Structure, Managerial Compensation

JEL Classification: D82, G32

working papers series