Hostname: page-component-77c89778f8-m8s7h Total loading time: 0 Render date: 2024-07-16T16:30:47.678Z Has data issue: false hasContentIssue false
  • English
  • Français

Executive Incentive Plans, Corporate Control, and Capital Structure

Published online by Cambridge University Press:  06 April 2009

Hamid Mehran
Get access Rights & Permissions [Opens in a new window]

Abstract

Agency theory recognizes that the interests of managers and shareholders may conflict and that, left on their own, managers may make major financial policy decisions, such as the choice of a capital structure, that are suboptimal from the shareholders' standpoint. The theory also suggests, however, that compensation contracts, managerial equity investment, and monitoring by the board of directors and major shareholders can reduce conflicts of interest between managers and shareholders. This research investigates the relationship between the firm's capital structure and 1) executive incentive plans, 2) managerial equity investment, and 3) monitoring by the board of directors and major shareholders. This paper finds a positive relationship between the firm's leverage ratio and 1) percentage of executives' total compensation in incentive plans, 2) percentage of equity owned by managers, 3) percentage of investment bankers on the board of directors, and 4) percentage of equity owned by large individual investors. These findings are consistent with the predictions of agency theory, suggesting, in turn, that capital structure models that ignore agency costs are incomplete.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 27 , Issue 4 , December 1992 , pp. 539 - 560
Copyright
Copyright © School of Business Administration, University of Washington 1992

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Agrawal, A., and Mandelker, G.. “Managerial Incentives and Corporate Investment and Financing Decisions.” Journal of Finance, 42 (09 1987), 823–838.CrossRefGoogle Scholar
Barton, S.; Hill, N.; and Sundaram, S.. “An Empirical Test of Stakeholder Theory Predictions of Capital Structure.” Financial Management, 18 (09 1989), 36–44.CrossRefGoogle Scholar
Baskin, J. “An Empirical Investigation of the Pecking Order Hypothesis.” Financial Management, 18 (09 1989), 26–35.CrossRefGoogle Scholar
Bradley, M.; Jarrell, G.; and Kim, E.. “On the Existence of an Optimal Capital Structure: Theory and Evidence.” Journal of Finance, 39 (07 1984), 857–880.CrossRefGoogle Scholar
Brickley, J., and James, C.. “The Takeover Market, Corporate Board Composition, and Ownership Structure: The Case of Banking.” Journal of Law and Economics, 30 (04 1987), 161–180.CrossRefGoogle Scholar
Brickley, J.; Lease, R.; and Smith, C.. “Ownership Structure and Voting on Antitakeover Amendments.” Journal of Financial Economics, 20 (03 1988), 267–292.CrossRefGoogle Scholar
Brickley, J., and Van Drunen, L.. “Residual Claims, Decision Rights and Board Structure.” Working Paper, William E. Simon Graduate School of Business Administration, Univ. of Rochester (1987).Google Scholar
Chaplinsky, S., and Niehaus, G.. “Inside Ownership, Leverage, and Internal Funds.” Working Paper, School of Business Administration, Univ. of Michigan (1988).Google Scholar
DeFusco, R.; Johnson, R.; and Zorn, T.. “The Effect of Executive Stock Option Plans on Stockholders and Bondholders.” Journal of Finance, 45 (06 1990), 617–628.CrossRefGoogle Scholar
Demsetz, H. “The Structure of Ownership and the Theory of the Firm.” Journal of Law and Economics, 26 (06 1983), 375–390.CrossRefGoogle Scholar
Donaldson, G. “Corporate Debt Capacity: A Study of Corporate Debt Capacity.” Boston, Division of Research, Harvard School of Business Administration (1961).Google Scholar
Eliot, J. “Control, Size, Growth and Financial Performance.” Journal of Financial and Quantitative Analysis, 7 (01 1972), 1309–1320.CrossRefGoogle Scholar
Ellsworth, R. “Subordinated Financial Strategy to Corporate Strategy.” Harvard Business Review, 61 (11/12 1983), 170–182.Google Scholar
Fama, E. “Agency Problems and the Theory of the Firm.” Journal of Political Economy, 88 (04 1980), 288–325.CrossRefGoogle Scholar
Fama, E., and Jensen, M.. “Separation of Ownership and Control.” Journal of Law and Economics, 26 (06 1983), 301–325.CrossRefGoogle Scholar
Fama, E., and Miller, M.. The Theory of Finance. Hinsdale, IL: Dryden (1972).Google Scholar
Friend, I., and Lang, L.. “An Empirical Test of the Impact of Management Self-interest on Corporate Capital Structure.” Journal of Finance, 43 (06 1988), 271–282.Google Scholar
Galai, D., and Masulis, R.. “The Option Pricing Model and the Risk Factor of Stock.” Journal of Financial Economics, 3 (01/03 1976), 53–81.CrossRefGoogle Scholar
Gilson, S. “Management Turnover and Financial Distress.” Journal of Financial Economics, 25 (12 1989), 241–262.CrossRefGoogle Scholar
Green, R. “Investment Incentives, Debt, and Warrants.” Journal of Financial Economics, 13 (03 1984), 115–136.CrossRefGoogle Scholar
Grossman, S., and Hart, O.. “Corporate Financial Structure and Managerial Incentives.” In The Economics of Information and Uncertainty, McCall, John, ed. Chicago, IL: Univ. of Chicago Press (1982).Google Scholar
Harris, M., and Raviv, A.. “Corporate Control Contests and Capital Structure.” Journal of Financial Economics, 20 (03 1988), 55–86.CrossRefGoogle Scholar
Haugen, R., and Senbet, L.. “Resolving the Agency Problems of External Capital through Options.” Journal of Finance, 36 (06 1981), 629–648.CrossRefGoogle Scholar
Holmstrom, B. “Managerial Incentive Problems: A Dynamic Perspective.” In Essays in Economics and Management in Honor of Lars Wahlbeck. Helsinki: Swedish School of Economics (1982).Google Scholar
Jensen, M. “Agency Costs of Free Cash Flows, Corporate Finance, and Takeover.” American Economic-Review, 76 (05 1986), 323–319.Google Scholar
Jensen, M., and Meckling, W.. “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure.” Journal of Financial Economics, 3 (10 1976), 305–360.CrossRefGoogle Scholar
Jensen, M., and Murphy, K.. “Performance Pay and Top-Management Incenitves.” Journal of Political Economy, 98 (05/06 1990), 225–264.CrossRefGoogle Scholar
Kim, H. “A Mean-Variance Theory of Optimal Capital Structure and Corporate Debt Policy.” Journal of Finance, 33 (03 1978), 45–64.Google Scholar
Kim, W., and Sorensen, E.. “Evidence on the Agency Costs of Debt on Corporate Debt Policy.” Journal of Financial and Quantitative Analysis, 21 (06 1986), 131–144.CrossRefGoogle Scholar
Kraus, A., and Litzenberger, R.. “A State-Preference Model of Optimal Financial Leverage.” Journal of Finance, 28 (09 1973), 911–922.Google Scholar
Lambert, R., and Larcker, D.. “Stock Options and Managerial Incentives.” Working Paper, The Wharton School, The Univ. of Pennsylvania (1985).Google Scholar
Lambert, R.; Larcker, D.; and Verrecchia, R.. “Portfolio Considerations in the Valuing of Executive Compensation.” Journal of Accounting Research, 29 (Spring 1991), 129–149.CrossRefGoogle Scholar
Larcker, D., and Balkcom, J.. “Executive Compensation Contracts and Investment Behavior: An Analysis of Mergers.” Working Paper, Northwestern Univ. (1984).Google Scholar
Long, M., and Malitz, E.. “Investment Patterns and Financial Leverage.” In Corporate Capital Structure in the United States, Friedman, B., ed. Chicago, IL: Univ. of Chicago Press (1985).Google Scholar
Masulis, R.The Debt/Equity Choice. Cambridge, MA: Ballinger (1988).Google Scholar
Modigliani, F., and Miller, M.. “The Cost of Capital, Corporation Finance, and the Theory of Investment.” American Economic Review, 48 (06 1958), 261–297.Google Scholar
Modigliani, F., and Miller, M.. “Corporate Income Taxes and the Cost of Capital.” American Economic Review. 53 (06 1963), 433–443.Google Scholar
Morck, R.; Shleifer, A.; and Vishny, R.. “Management Ownership and Corporate Performance: An Empirical Analysis.” Journal of Financial Economics, 20 (03 1988), 293–316.CrossRefGoogle Scholar
Murphy, K. “Corporate Performance and Managerial Remuneration: An Empirical Analysis.” Journal of Accounting and Economics, 7 (04 1985), 11–42.CrossRefGoogle Scholar
Murphy, K. “Incentives, Learning, and Compensation: A Theoretical and Empirical Investigation of Managerial Labor Contracts.” Rand Journal of Economics, 17 (Spring 1986a), 59–76.CrossRefGoogle Scholar
Murphy, K. “The Determinants of Executive Compensation: Are Managers Entrepreneurs or Employees?” Working Paper, William E. Simon Graduate School of Business Administration, Univ. of Rochester (1986b).Google Scholar
Myers, S. “Determinants of Corporate Borrowing.” Journal of Financial Economics, 5 (11 1977), 147–175.CrossRefGoogle Scholar
Myers, S. “Still Searching for Optimal Capital Structure.” In Are the Distinctions between Debt and Equity Disappearing? Kopcke, R. and Rosengren, E., eds. Boston, MA: Federal Reserve Bank of Boston (1989).Google Scholar
Myers, S., and Majluf, N.. “Corporate Financing and Investment Decisions when the Firm Has Information that Investors Do Not Have.” Journal of Financial Economics, 13 (06 1984), 187–221.CrossRefGoogle Scholar
Noreen, E., and Wolfson, M.. “Equilibrium Warrant Pricing Models and Accounting for Executive Stock Options.” Journal of Accounting Research, 19 (Autumn 1981), 384–398.CrossRefGoogle Scholar
Pound, J. “Proxy Context and the Efficiency of Shareholders Oversight.” Journal of Financial Economics, 20 (03 1988), 237–266.CrossRefGoogle Scholar
Roe, M. “Political and Legal Restraints on Ownership and Control of Public Companies.” Journal of Financial Economics, 27 (10 1990), 7–42.CrossRefGoogle Scholar
Ross, S. “The Determination of Financial Structure: The Incentive Signalling Approach.” Bell Journal of Economics, 8 (Spring 1977), 23–40.CrossRefGoogle Scholar
Ross, S. “Debt and Taxes and Uncertainty.” Journal of Finance. 40 (07 1985), 637–656.CrossRefGoogle Scholar
Scott, J. “A Theory of Optimal Capital Structure.” Bell Journal of Economics, 7 (Spring 1976), 33–54.CrossRefGoogle Scholar
Scott, J. “Bankruptcy, Secured Debt, and Optimal Capital Structure.” Journal of Finance, 32 (05 1977), 1–20.CrossRefGoogle Scholar
Shleifer, A., and Vishny, R.. “Large Shareholders and Corporate Control.” Journal of Political Economy, 95 (06 1986), 461–488.CrossRefGoogle Scholar
Smith, C, and Stulz, R.. “The Determinants of Firms' Hedging Policies.” Journal of Financial and Quantitative Analysis, 20 (12 1985), 391–405.CrossRefGoogle Scholar
Smith, C., and Warner, J.. “On Financial Contracting: An Analysis of Bond Covenants.” Journal of Financial Economics, 7 (06 1979), 117–161.CrossRefGoogle Scholar
Smith, C., and Watts, R.. “Incentive and Tax Effects of U.S. Executive Compensation Plans.” Australian Management Journal, 7 (12 1982), 139–157.Google Scholar
Smith, C., and Watts, R.. “The Investment Opportunity Set and Corporate Policy Choices.” Working Paper, Univ. of Rochester (1986).Google Scholar
Smith, C., and Zimmerman, J.. “Valuing Employee Stock Option Plans Using Option Pricing Models.” Journal of Accounting Research, 14 (Autumn 1976), 357–364.CrossRefGoogle Scholar
Stulz, R. “Managerial Control of Voting Rights: Financing Policies and the Market for Corporate Control.” Journal of Financial Economics, 20 (03 1988), 25–54.CrossRefGoogle Scholar
Titman, S. “The Effect of Capital Structure on a Firm's Liquidation Decision.” Journal of Financial Economics, 13 (03 1984), 137–152.CrossRefGoogle Scholar
Titman, S., and Wessels, R.. “The Determinants of Capital Structure Choice.” Journal of Finance, 43 (03 1988), 1–20.CrossRefGoogle Scholar
Vancil, R.Passing the Baton: Managing the Process of CEO Succession. Boston, MA: Harvard Business School Press (1987).Google Scholar
Warner, J. “Bankruptcy Costs: Some Evidence.” Journal of Finance, 32 (05 1977), 337–347.CrossRefGoogle Scholar
Weisbach, M. “Outside Directors, Monitoring, and the Turnover of Chief Executive Officers: An Empirical Analysis.” Journal of Financial Economics, 20 (03 1988), 431–460.CrossRefGoogle Scholar
Williamson, O. “Corporate Finance and Corporate Governance.” Journal of Finance, 43 (07 1988), 567–592.CrossRefGoogle Scholar
White, H. “A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity.” Econometrica, 48 (05 1980), 817–838.CrossRefGoogle Scholar