Agency Dynamics in Corporate Finance

Posted: 18 Nov 2016

See all articles by Bart M. Lambrecht

Bart M. Lambrecht

University of Cambridge - Judge Business School; Centre for Economic Policy Research (CEPR)

Stewart C. Myers

Massachusetts Institute of Technology (MIT); National Bureau of Economic Research (NBER)

Date Written: October 2016

Abstract

We describe a framework for analyzing the dynamics of investment, borrowing, and payout decisions by public corporations. We assume that managers act entirely in their own long-run interests, subject to a governance constraint that limits their rents. Risk-neutral managers invest to maximize value but wait too long to disinvest. Efficient disinvestment can be forced by the right level of debt or by takeovers. Risk-averse managers underinvest; they do not waste free cash flow, because the governance constraint is binding. They smooth rents and consequently payout, so that changes in borrowing become a shock absorber for volatility of operating income. We obtain the Lintner model of payout if risk-averse managers have a utility function with habit formation. We show how to adapt the dynamic framework to analyze several other issues, including the effects of asymmetric information. We show that Lintner-style payout smoothing can also arise when risk-neutral managers are better informed than outsiders.

Suggested Citation

Lambrecht, Bart and Myers, Stewart C., Agency Dynamics in Corporate Finance (October 2016). Annual Review of Financial Economics, Vol. 8, pp. 53-80, 2016. Available at SSRN: https://ssrn.com/abstract=2870869 or http://dx.doi.org/10.1146/annurev-financial-121415-032937

Bart Lambrecht (Contact Author)

University of Cambridge - Judge Business School ( email )

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Centre for Economic Policy Research (CEPR) ( email )

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Stewart C. Myers

Massachusetts Institute of Technology (MIT) ( email )

Sloan School of Management
Cambridge, MA 02142
United States
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617-258-6855 (Fax)

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
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