Equity Financing in a Myers-Majluf Framework with Private Benefits of Control
47 Pages Posted: 8 Dec 2004
Date Written: April 2004
This paper generalizes the Myers and Majluf (1984) model by introducing an agency cost structure based on private benefits of control. This new model predicts that many corporate finance variables each have opposing effects on under- and overinvestment. Private benefits exacerbate overinvestment but, interestingly, a small amount of private benefits can enhance firm value by alleviating underinvestment. Likewise, an increase in insider ownership alleviates overinvestment but aggravates underinvestment. When private benefits are small, the adverse effect of insider ownership on underinvestment tends to dominate. When there are considerable private benefits, the incentive-alignment effect of insider ownership is pronounced. Additionally, this model reconciles existing equity financing theories on announcement effects. It helps resolve the puzzle that small-growth firms do not seem to have an asymmetric information disadvantage when they issue new equity.
Keywords: Equity financing, Private benefits of control, Underinvestment, Overinvestment, Announcement effect
JEL Classification: G14, G31, G32
Suggested Citation: Suggested Citation