Managerial Conservatism, Project Choice and Debt

Review of Financial Studies, Vol. 5, No. 3, pp. 437-470, 1992

Posted: 1 Dec 2008

See all articles by Anjan V. Thakor

Anjan V. Thakor

Washington University, Saint Louis - John M. Olin School of Business; European Corporate Governance Institute (ECGI)

David A. Hirshleifer

University of California, Irvine - Paul Merage School of Business; NBER

Abstract

We show that the incentive for managers to build their reputations distorts firms' investment policies in favor of relatively safe projects, thereby aligning managers' interests with those of bond-holders, even though managers are hired and fired by shareholders. This effect opposes the familiar agency problem of risky debt that is imperfectly covenant-protected, wherein shareholders are tempted to favor excessively risky projects in order to expropriate bondholders. Consequently, when managerial concern for reputation results in conservatism, it can actually make shareholders better off ex ante by allowing the firm to issue more debt. We examine how the optimal choice of leverage from the shareholders' standpoint is influenced by takeover activity, and how the adoption of anti-takeover measures affects a firm's investment policy and leverage choice.

Suggested Citation

Thakor, Anjan V. and Hirshleifer, David A., Managerial Conservatism, Project Choice and Debt. Review of Financial Studies, Vol. 5, No. 3, pp. 437-470, 1992. Available at SSRN: https://ssrn.com/abstract=1286308

Anjan V. Thakor

Washington University, Saint Louis - John M. Olin School of Business ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

David A. Hirshleifer (Contact Author)

University of California, Irvine - Paul Merage School of Business ( email )

Irvine, CA California 92697-3125
United States

HOME PAGE: http://sites.uci.edu/dhirshle/

NBER ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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