The Impact of Managerial Discretion and Control Challenges on Dynamic Capital Structure

48 Pages Posted: 28 Oct 2004

See all articles by Sergei Polevikov

Sergei Polevikov

University of Rochester - Simon Business School

Date Written: December 19, 2003

Abstract

This paper develops a model that analyzes the impact of manager-stockholder conflicts and control challenge threats on leverage, firm value and debt restructuring frequency in a contingent claims framework. This is the first theoretical study to merge several lines of research - market for corporate control, manager-shareholder conflict, dynamic capital structure, and the effect of compensation policy on managerial decisions - in one framework. This richness of the model allows to reconcile some of the on-going controversy in the corporate finance literature regarding the leverage-profitability relationship - namely, empirical support for the pecking order theory (e.g. Fama and French, 2002), and theoretical appeal of the trade-off theory (e.g. Jensen, 1986). Another implication of this paper is that control change threats are relatively ineffective for high free cash flow firms, in which case shareholders need to resort to compensation policy.

Keywords: Dynamic capital structure, market for corporate control, investment policy, financing policy, manager-shareholder conflict, Brownian motion

JEL Classification: C61, C63, G13, G31, G32, G33, G34

Suggested Citation

Polevikov, Sergei, The Impact of Managerial Discretion and Control Challenges on Dynamic Capital Structure (December 19, 2003). Available at SSRN: https://ssrn.com/abstract=598421 or http://dx.doi.org/10.2139/ssrn.598421

Sergei Polevikov (Contact Author)

University of Rochester - Simon Business School ( email )

River Campus
500 Joseph C. Wilson Blvd.
Rochester, NY 14627
United States

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