Manager Characteristics and Capital Structure: Theory and Evidence

73 Pages Posted: 19 Mar 2009 Last revised: 25 May 2011

See all articles by Sanjai Bhagat

Sanjai Bhagat

University of Colorado at Boulder - Department of Finance

Brian J. Bolton

IMD Business School, Global Board Center

Ajay Subramanian

Georgia State University

Date Written: May 23, 2011

Abstract

We theoretically and empirically investigate the effects of manager-specific characteristics on capital structure. We develop a dynamic structural model in which a manager affects a firm's earnings through her ability and effort. The manager receives dynamic incentives through explicit contracts with shareholders. We derive the manager's contracts and implement them through financial securities. The firm's resulting capital structure is dynamic, and consists of long-term debt, short-term debt, inside equity, and outside equity. The different components of the firm's capital structure reflect the interactive effects of taxes, bankruptcy costs, as well as agency conflicts between the undiversified manager and well-diversified outside investors. The analysis of the model generates the following novel testable predictions: (i) Long-term debt declines with the manager's ability and with her inside equity ownership in the firm. (ii) Short-term debt declines with the manager's ability and increases with her equity ownership. (iii) Long-term debt increases with the firm's short-term risk and decreases with its long-term risk risk. (iv) Short-term debt declines with short-term risk. With the exception of the predicted relation between short-term debt and manager ownership, we show significant support for the above testable implications in our empirical analysis. Our theoretical and empirical results show that managerial discretion and manager-specific characteristics are important determinants of firms' financial policies.

Keywords: Manager Ability, Risk Aversion, Manager Ownership, Capital Structure

JEL Classification: G32, D92, D86

Suggested Citation

Bhagat, Sanjai and Bolton, Brian J. and Subramanian, Ajay, Manager Characteristics and Capital Structure: Theory and Evidence (May 23, 2011). Journal of Financial and Quantitative Analysis (JFQA), December 2011. Available at SSRN: https://ssrn.com/abstract=1360244

Sanjai Bhagat

University of Colorado at Boulder - Department of Finance ( email )

Campus Box 419
Boulder, CO 80309
United States
303-492-7821 (Phone)

Brian J. Bolton

IMD Business School, Global Board Center ( email )

Ch. de Bellerive 23
P.O. Box 915
CH-1001 Lausanne
Switzerland
+41216180225 (Phone)

Ajay Subramanian (Contact Author)

Georgia State University ( email )

Depts. of Finance & Risk Management and Insurance
P.O. Box 4050
Atlanta, GA 30303
United States
404-413-7483 (Phone)

HOME PAGE: http://robinson.gsu.edu/profile/ajay-subramanian/

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