Narrow Results

Using an agency theoretical framework, this paper extends the optimal capital structure literature by modeling the rivalry between equity and debt to arrive at some very fundamental results involving endogeneity of bankruptcy, equilibrium interest rates, pricing of risk-free/risky debt and pareto-optimal financing techniques.

Though maturity matching is a common practice in real finance, no academic study has been conducted yet on cross-sectional variations in the degree of maturity matching. This study derives hypotheses on the maturity matching and empirically tests them. We show that firms with a higher degree of maturity matching are more likely to stabilize equity values: they have lower stock return volatilities. We also show evidence supporting the existence of an optimal level of maturity matching. Though financially strong firms generally employ a higher degree of maturity matching, the relationship between financial strength and maturity matching is not monotonic.

Controlling shareholders' share collateral is a new source of the deviation of cash flow rights and control rights leading to minority shareholder expropriation. However, controlling shareholders' share collateral is not forbidden and has not received particular restriction leading to its popularity in the capital markets. Neglecting the potential agency costs resulting from controlling shareholders' share collateral would hurt the interests of creditors and minority shareholders. We need legal regulation on controlling shareholders' share collateral to reinforce corporate governance mechanism to protect the interests of creditors and minority shareholders.

The main purpose of this paper is to examine two commonly used alternatives to traditional repricing (TR) of executive stock options (ESOs) in a dynamic agency model. TR practices have become obsolete since new accounting rules took effect in July 2000. To avoid associated variable accounting charges that cause uncertainty in future reported earnings, companies have tried several TR alternatives as solutions to rescuing underwater options. We justify the occurrence of TR alternatives and quantify the impact of the marking-to-market feature imbedded in the new accounting rules. We also propose an incentive measure which is comparable to the subjective value of ESOs claimed by Ingersoll, J (2006) to rank TR alternatives in terms of agent's incentive.

This paper examines stock repurchases from an agency perspective by identifying agency costs across three dimensions — interest conflicts and information asymmetry, managerial discretion, and the use of alternative mechanisms to mitigate agency conflicts. We use ownership structure as a proxy for interest conflicts and information asymmetry, employ cash balance and free cash flow as two measures of managerial discretion, and consider cash dividends and interest-bearing liabilities as alternative vehicles for distributing cash. We find that a monitoring structure motivates managers to mitigate agency costs through stock repurchases. Particularly, monitored firms with higher levels of cash balance prefer cash dividends to stock repurchases, whereas monitored firms with more cash dividends repurchase more shares because of their stronger incentive to mitigate agency costs. However, when firms have a very high level of dividends, they substitute stock repurchases for dividends to avoid a dividend cut in the future.

The paper examines the relationship between ownership concentrations and tax avoidance for small–medium enterprises (SMEs) in India. With a panel dataset built from small- and medium-sized enterprise surveys over the period between 2013 and 2014, we find that SMEs with concentrated ownership have a negative association with tax avoidance. The result is more pronounced for SMEs headquartered in states/provinces with stronger economic and institutional environment. The results also indicate that for any two SMEs with similar levels of ownership concentration, the SME with higher capital needs is more likely to avoid taxes.

This study investigates whether and how the CEOs’ political spending choice is associated with their earnings management behavior. Using a sample of 8,502 firm-year observations from S&P 500 firms during 1993–2012 over 10 election cycles, we provide empirical evidence that CEOs making political spending mainly through the corporate channel to recipients advised by the firms’ own political action committees engage in less earnings management than those making political spending mainly through the private channel to their own selected recipients. This finding suggests that CEOs’ political spending choice of the private channel over the corporate channel represents their strong self-interests and is associated with higher agency costs. We further show that the distinction between the two channels is less important when the CEOs’ private political spending patterns are aligned with those of their own firms. Our results are robust to techniques alleviating the potential endogeneity issue related to political spending behavior.

This concept paper synthesizes two theories of executive remuneration. Soundly motivated, the two manifestations of agency theory of equity examine the market for managerial labor. The first theory models two families of determinants of Chief Executive Officer remuneration: economic factors and wealth expropriation. The second theory models equilibrium corporate governance quality by treating the Chief Executive Officer as a rational maximizer of her own wealth utility. This theory complements the first by facilitating consideration of the contextual role played by Chief Executive Officer greed, in undermining equilibrium pricing of economic factors and the efficacy of corporate governance mechanisms.

We provide evidence on the covenant structure of corporate loan agreements. Building on the work of Jensen and Meckling [1976, Theory of the Firm: Managerial Behavior, Agency Costs, and Captial Structure, Journal of the Financial Economics 3, 305–360], Myers [1977, Determinants of Corporate Borrowing, Journal of Financial Economics 5, 145–147] and Smith and Warner [1979, On Financial Contracting: An Analysis of Bond Covenants, Journal of Financial Economics 7(2), 117–161]. We summarize and test the implications for what we refer to as the Agency Theory of Covenants (ATC), using a large sample of privately placed corporate debt. Our results are consistent with many of the implications of the ATC, including a negative relation between the promised yield on corporate debt and the presence of covenants. We also find that borrower and lender characteristics, as well as macroeconomic factors, determine covenant structure. Loans are more likely to include protective covenants when the borrower is small, has high growth opportunities or is highly levered. Loans made by investment banks and syndicated loans are also more likely to include protective covenants, as are loans made during recessionary periods or when credit spreads are large. Finally, we show that consistent with the ATC, firms that elect to issue private rather than public debt are smaller, have greater growth opportunities, less long-term debt, fewer tangible assets, more volatile cash flows and include more covenants in their debt agreements. An important byproduct of our analysis is to demonstrate empirically that covenant structure and the yield on corporate debt are determined simultaneously.

In this chapter, the principal–agent problem is addressed. The agency problem is explained along with real cases used as examples that have been analytically described. The different types of the principal–agent problems are presented and analyzed, along with ways of mitigating the problem.

Key takeaways:

• The agency problem arises when incentives or motivations arise in the one party (agent) that does not act for the best interest of another (principal).
• Agency problems can be reduced through regulations or by incentivizing an agent to act in accordance with the principal’s best interests.