Leverage Dynamics under Managerial Discretion

50 Pages Posted: 11 Oct 2019 Last revised: 6 Jan 2021

See all articles by Tak-Yuen Wong

Tak-Yuen Wong

National Tsing Hua University - Department of Quantitative Finance

Date Written: January 6, 2021


Abstract I study leverage dynamics when the manager has discretion over the firm's debt policy but cannot commit to it ex-ante. Private benefits of control reduce the manager's incentives to ratchet up leverage and may induce active debt repurchase over time. Therefore, agency frictions prevent excessive leveraging and increase the funding advantage of debt. Firms with weak governance and low managerial ownership favor long-term debt, have high debt capacity, maintain low target leverage, and adjust the debt level faster towards the target. Finally, firms with high agency costs remain persistently unlevered in equilibrium. This result offers a potential resolution for the zero leverage puzzle.

Keywords: leverage ratchet effect, commitment, managerial agency, governance, debt maturity, capital structure, zero leverage puzzle

JEL Classification: G3, G32, G34

Suggested Citation

Wong, Tak-Yuen, Leverage Dynamics under Managerial Discretion (January 6, 2021). Available at SSRN: https://ssrn.com/abstract=3462343 or http://dx.doi.org/10.2139/ssrn.3462343

Tak-Yuen Wong (Contact Author)

National Tsing Hua University - Department of Quantitative Finance ( email )

101, Section 2, Kuang-Fu Road
Hsinchu, Taiwan 300

HOME PAGE: http://https://sites.google.com/site/etywong110/

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