A Complementary Approach to the Financial and Strategy Views of Capital Structure: Theory and Evidence from the Ownership Structure
51 Pages Posted: 14 Feb 2005
Date Written: February 2, 2005
This paper provides a complementary approach to the financial and strategy views of capital structure. According to our ownership view, capital structure is partly determined by the incentives and the goals of those who are in control of the firm. Our results strongly support this view. As a consequence of managerial entrenchment and rent expropriation phenomena, self-interested agents (entrenched managers and controlling owners) choose the capital structure according to the debt ratios more appropriate for their own best interest. Additionally, we find evidence of an interaction effect between insider ownership and ownership concentration; particularly, the debt increments promoted by outside owners are larger when managers are entrenched. Finally, further findings are found according to firm-specific characteristics. The most relevant characteristic is the free cash flow, which totally dominates the effects of ownership over debt. We also find that when the level of intangible assets is high, more debt is used to control for the managerial discretion associated with these assets. Regarding investment opportunities, our findings confirm that debt is an effective mechanism to prevent firms from overinvesting, since when firms do not have valuable investment opportunities the increment in leverage is larger.
Keywords: Capital structure, ownership, managerial entrenchment, rent expropriation
JEL Classification: G32
Suggested Citation: Suggested Citation