Solving the Multi-Period Agency Problem and Design of Corporate Securities

35 Pages Posted: 26 Feb 2007

See all articles by Ren-Raw Chen

Ren-Raw Chen

Fordham University - Gabelli School of Business

Hsuan-Chu Lin

National Cheng Kung University - Accounting

Michael S. Long

Rutgers University at Newark

Date Written: February 2007

Abstract

This paper identifies and solves the multi-period agency problem. Overcoming the major weakness of traditional agency theory in a one period world, we adopt a multi-period option method to show adverse incentive problems with debt solving for the actual agency cost using compound options. It does not require asymmetric information as exists with current agency models. We find that firms can have debts greater than their asset value and continue to operate as long as current payments are being met. This situation creates an incentive for them to sell off their best assets that increases the risk of their remaining business and reduces survival. A major result of this model is to show why sinking funds actually increase a firm's agency costs explaining the demise of the traditional sinking fund over the last twenty years.

Keywords: multi-period agency problem, compound options, bankruptcy, sinking funds

JEL Classification: G33, G34

Suggested Citation

Chen, Ren-Raw and Lin, Hsuan-Chu and Long, Michael S., Solving the Multi-Period Agency Problem and Design of Corporate Securities (February 2007). Available at SSRN: https://ssrn.com/abstract=965070 or http://dx.doi.org/10.2139/ssrn.965070

Ren-Raw Chen (Contact Author)

Fordham University - Gabelli School of Business ( email )

113 West 60th Street
Bronx, NY 10458
United States

Hsuan-Chu Lin

National Cheng Kung University - Accounting ( email )

1 Ta-Hsueh Road
Tainan, 701
Taiwan

Michael S. Long

Rutgers University at Newark ( email )

111 Washington Avenue
Newark, NJ 07102
United States
973-353-5471 (Phone)

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