Managerial Entrenchment and the Debt-Equity Choice

OK we’ve heard all about shareholder-manager conflicts over the past few years (see Enron, Adelphia, Tyco etc.). And as a result we’ve heard all about corporate governance. But how does it tie back to the classroom in a concrete manner? One of the most frequent ways is to focus on the problems of managerial risk aversion. (For instance: due to risk aversion managers have incentives to use less debt than is optimal through shareholder eyes (Fama 1980)). Kayhan gives us evidence that this conflict exists. She investigates about 1200 firms per year from 1990-2002 and finds that “entrenched managers” have lower leverage than their industry peers (consistent with Mehran 1992). Interestingly she finds the lower leverage is achieved by both more equity issuances as well as lower dividend payouts. [ Annotation]

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