A Model of Market Discipline

59 Pages Posted: 3 Jun 2020 Last revised: 17 Aug 2022

See all articles by Colin Ward

Colin Ward

University of Minnesota - Carlson School of Management

Chao Ying

Chinese University of Hong Kong

Date Written: August 16, 2022

Abstract

We develop an equilibrium model where refinancing and managerial incentives are jointly determined to quantify external finance's influence on management's ex ante behavior. In its calibration to US data we find that free cash flow is directed primarily towards mitigating agency conflicts, not financial frictions. Its counterfactuals suggest that firm value can be raised by 40 basis points either by decreasing agency conflicts by 1 percent or by increasing refinancing costs by 4 percent, as this makes shareholders' threat of terminating management more credible.

Keywords: Financial Frictions, Agency Conflicts, Dynamic Contracting, Market Discipline

JEL Classification: D21, D61, D92, G32, G35, L22

Suggested Citation

Ward, Colin and Ying, Chao, A Model of Market Discipline (August 16, 2022). Available at SSRN: https://ssrn.com/abstract=3601084 or http://dx.doi.org/10.2139/ssrn.3601084

Colin Ward (Contact Author)

University of Minnesota - Carlson School of Management ( email )

Carlson School of Management
321 19th Avenue South
Minneapolis, MN 55455
United States

Chao Ying

Chinese University of Hong Kong ( email )

Cheng Yu Tung Building
12 Chak Cheung Street
Shatin, NT
Hong Kong

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