Managerial Compensation and Capital Structure Under Asymmetric Information
27 Pages Posted: 2 Mar 2007
Date Written: January 2007
We consider project financing when the project quality is private information of the manager and, given its inherent quality, the project viability depends on the manager exerting unobservable effort. We show that capital structure matters even though managerial contracts are optimally designed. We also provide an explanation of why good firms issue both debt and underpriced equity (even if the bankruptcy and agency costs of debt are zero). Finally, we show that the optimal financial contract can be implemented by a combination of debt and equity. Our results have a number of testable implications.
Keywords: Asymmetric Information, Capital Structure, Managerial Compensation
JEL Classification: D82, G32
Suggested Citation: Suggested Citation