Leverage, Executive Incentives and Corporate Governance

30 Pages Posted: 16 Mar 2013

See all articles by Mahmoud Agha

Mahmoud Agha

University of Western Australia

Date Written: March 2013


This paper analyses the effect of executive incentives and internal governance on capital structure. Using a large sample of non‐financial US‐listed firms over the period 1999–2005, it is found that managers have different attitudes towards leverage when offered different incentive schemes; leverage initially decreases in bonuses and stock incentives and then increases in these incentives after a certain incentive level, suggesting the existence of the entrenchment–alignment effects under these incentive schemes. In contrast, leverage initially increases in option incentives and then decreases after a certain option incentive level. When all of these incentive schemes are combined together into a single incentive package, the entrenchment–alignment effects prevail. It is also found that leverage increases in internal governance and managers behave differently under different governance regimes such that the entrenchment–alignment effects prevail under weak governance firms, whereas the alignment–entrenchment effects prevail under strong governance firms. The results also suggest that managers’ target leverage ratio is less than the one predicted by theory or preferred by firm shareholders.

Keywords: Leverage, Incentive schemes, Internal governance, Alignment effect, Entrenchment effect

JEL Classification: G3, G32

Suggested Citation

Agha, Mahmoud, Leverage, Executive Incentives and Corporate Governance (March 2013). Accounting & Finance, Vol. 53, Issue 1, pp. 1-30, 2013. Available at SSRN: https://ssrn.com/abstract=2234239 or http://dx.doi.org/10.1111/j.1467-629X.2011.00450.x

Mahmoud Agha (Contact Author)

University of Western Australia ( email )

Crawley, Western Australia 6009

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