The Dynamics of Investment, Payout and Debt
56 Pages Posted: 2 Jun 2014
Date Written: April 2014
We present a dynamic agency model of investment, borrowing and payout decisions by a mature corporation operating in perfect financial markets. Risk-averse managers implement an inter-temporal strategy that maximizes their lifetime utility of managerial rents. They under-invest and smooth payout and rents. Debt is the shock-absorber for operating income and investment. Managers do not rebalance capital structure, so shocks to debt levels persist. Managers implement precautionary savings by paying down debt, even when interest is tax-deductible. We generate empirical predictions that differ from conventional agency models and from dynamic models based on financing frictions.
Keywords: agency, financing policy, investment, payout
JEL Classification: G31, G32
Suggested Citation: Suggested Citation