Equity Financing in a Myers-Majluf Framework with Private Benefits of Control

47 Pages Posted: 8 Dec 2004

See all articles by Xueping Wu

Xueping Wu

City University of Hong Kong (CityU) - Department of Economics & Finance

Zheng Wang

City University of Hong Kong (CityU) - Department of Economics & Finance

Multiple version iconThere are 2 versions of this paper

Date Written: April 2004

Abstract

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

Wu, Xueping and Wang, Zheng, Equity Financing in a Myers-Majluf Framework with Private Benefits of Control (April 2004). Available at SSRN: https://ssrn.com/abstract=352320 or http://dx.doi.org/10.2139/ssrn.352320

Xueping Wu (Contact Author)

City University of Hong Kong (CityU) - Department of Economics & Finance ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong
+852 3442 7577 (Phone)
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HOME PAGE: http://personal.cityu.edu.hk/~efxpwu/

Zheng Wang

City University of Hong Kong (CityU) - Department of Economics & Finance ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong

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