Risk and Leverage Choices in Owner-Controlled Firms

33 Pages Posted: 29 Sep 2015 Last revised: 27 Apr 2017

See all articles by Mike Burkart

Mike Burkart

Swedish House of Finance; London School of Economics and Political Science, Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Pavle Radicevic

UNSW Australia Business School, School of Banking and Finance

Jin Yu

Monash University -Department of Banking and Finance

Date Written: April 27, 2017

Abstract

Private benefits of control distort the risk choices of owner-managers. In particular, when riskier projects entail a larger increase in cash flow than in private benefits (if successful), (more) equity financing renders the owner-manager (more) conservative, which lowers both expected payoff and pledgeable income. This novel cost of outside equity can be mitigated by issuing risky debt. In fact, risky debt and outside equity are complements for implementing a given risk choice, and an appropriately chosen mix of debt and equity allows the owner-manager to commit to the ex ante optimal risk level. Thus, our model provides a rationale for the co-existence of risky debt and outside equity derived from a simple risk choice problem in the presence of private benefits.

Keywords: Capital structure, risk-taking

JEL Classification: G32

Suggested Citation

Burkart, Mike C. and Radicevic, Pavle and Yu, Jin, Risk and Leverage Choices in Owner-Controlled Firms (April 27, 2017). Available at SSRN: https://ssrn.com/abstract=2667280 or http://dx.doi.org/10.2139/ssrn.2667280

Mike C. Burkart

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

London School of Economics and Political Science, Department of Finance ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

HOME PAGE: http://www.cepr.org/default_static.htm

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Pavle Radicevic

UNSW Australia Business School, School of Banking and Finance ( email )

Sydney, NSW 2052
Australia

Jin Yu (Contact Author)

Monash University -Department of Banking and Finance ( email )

Melbourne
Australia
+61 3 99034590 (Phone)

HOME PAGE: http://sites.google.com/site/jinyufinecon/

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