1932
0
  1. Home
  2. A-Z Publications
  3. Annual Review of Financial Economics
  4. Volume 8, 2016
  5. Article

Annual Review of Financial Economics

Volume 8, 2016

Agency Dynamics in Corporate Finance

Abstract

We describe a framework for analyzing the dynamics of investment, borrowing, and payout decisions by public corporations. We assume that managers act entirely in their own long-run interests, subject to a governance constraint that limits their rents. Risk-neutral managers invest to maximize value but wait too long to disinvest. Efficient disinvestment can be forced by the right level of debt or by takeovers. Risk-averse managers underinvest; they do not waste free cash flow, because the governance constraint is binding. They smooth rents and consequently payout, so that changes in borrowing become a shock absorber for volatility of operating income. We obtain the Lintner model of payout if risk-averse managers have a utility function with habit formation. We show how to adapt the dynamic framework to analyze several other issues, including the effects of asymmetric information. We show that Lintner-style payout smoothing can also arise when risk-neutral managers are better informed than outsiders.

Keyword(s): agency, debt, investment, payout, takeover
Loading

Article metrics loading...

/content/journals/10.1146/annurev-financial-121415-032937
2016-10-23
2024-12-01
Loading full text...

Full text loading...

/deliver/fulltext/financial/8/1/annurev-financial-121415-032937.html?itemId=/content/journals/10.1146/annurev-financial-121415-032937&mimeType=html&fmt=ahah

Literature Cited

  1. Acharya VV, Lambrecht BM. 2015. A theory of income smoothing when insiders know more than outsiders. Rev. Financ. Stud. 28:2534–74 [Google Scholar]
  2. Acharya VV, Myers SC, Rajan RG. 2011. The internal governance of firms. J. Finance 66:689–720 [Google Scholar]
  3. Bhattacharya S. 1979. Imperfect information, dividend policy, and the `bird in the hand' fallacy. Bell J. Econ. Manag. Sci. 10:259–70 [Google Scholar]
  4. Biais B, Mariotti T, Rochet JC, Villeneuve S. 2010. Large risks, limited liability, and dynamic moral hazard. Econometrica 78:73–118 [Google Scholar]
  5. Bolton P, Chen H, Wang N. 2011. A unified theory of Tobin's Q, corporate investment, financing, and risk management. J. Finance 66:1545–78 [Google Scholar]
  6. Bolton P, Scharfstein D. 1990. A theory of predation based on agency problems in financial contracting. Am. Econ. Rev. 80:93–106 [Google Scholar]
  7. Brennan MJ, Schwartz ES. 1985. Evaluating natural resource investments. J. Bus 58:135–57 [Google Scholar]
  8. Burkart M, Gromb D, Panunzi F. 1997. Large shareholders, monitoring, and the value of the firm. Q. J. Econ 112:693–728 [Google Scholar]
  9. Caballero RJ. 1990. Consumption puzzles and precautionary savings. J. Monet. Econ 25:113–36 [Google Scholar]
  10. Chen H, Miao J, Wang N. 2010. Entrepreneurial finance and nondiversifiable risk. Rev. Financ. Stud 234348–88 [Google Scholar]
  11. Chu J, Faasse J, Rau PR. 2015. Do compensation consultants enable higher CEO pay? New evidence from recent disclosure rule changes Work. Pap., Judge Bus. Sch., Univ. Cambridge [Google Scholar]
  12. Décamps JP, Mariotti T, Rochet JC, Villeneuve S. 2011. Free cash flow, issuance costs and stock prices. J. Finance 661501–44 [Google Scholar]
  13. DeMarzo PM, Fishman MJ. 2007. Agency and optimal investment dynamics. Rev. Financ. Stud 20:151–88 [Google Scholar]
  14. DeMarzo PM, Fishman MJ, He Z, Wang N. 2012. Dynamic agency and the q theory of investment. J. Finance 67:2295–340 [Google Scholar]
  15. DeMarzo PM, Sannikov Y. 2006. Optimal security design and dynamic capital structure in a continuous-time agency model. J. Finance 61:2681–724 [Google Scholar]
  16. DeMarzo PM, Sannikov Y. 2015. Learning, termination, and payout policy in dynamic incentive contracts Work. Pap., Stanford Grad. Sch. Bus., Stanford Univ. [Google Scholar]
  17. Diamond D. 1984. Financial intermediation and delegated monitoring. Rev. Econ. Stud 51:393–414 [Google Scholar]
  18. Fischer EO, Heinkel RL, Zechner J. 1989. Dynamic capital structure choice: theory and tests. J. Finance 44:19–40 [Google Scholar]
  19. Gorton G, Kahl M, Rosen R. 2009. Eat or be eaten: a theory of mergers and firm size. J. Finance 64:1291–344 [Google Scholar]
  20. Grossman SJ, Hart OD. 1988. One share–one vote and the market for corporate control. J. Financ. Econ 20:175–202 [Google Scholar]
  21. Hart O. 1995. Firms, Contracts, and Financial Structure Oxford, UK: Clarendon Press [Google Scholar]
  22. Jensen MC. 1986. Agency costs of free cash flow, corporate finance and takeovers. Am. Econ. Rev 76:323–29 [Google Scholar]
  23. Jin L, Myers SC. 2006. R2 around the world: new theory and new tests. J. Financ. Econ 79:257–92 [Google Scholar]
  24. John K, Williams J. 1985. Dividends, dilution, and taxes: a signaling equilibrium. J. Finance 49:1053–70 [Google Scholar]
  25. Lambrecht BM, Myers SC. 2007. A theory of takeovers and disinvestment. J. Finance 62:809–45 [Google Scholar]
  26. Lambrecht BM, Myers SC. 2008. Debt and managerial rents in a real-options model of the firm. J. Financ. Econ 89:209–31 [Google Scholar]
  27. Lambrecht BM, Myers SC. 2012. A Lintner model of payout and managerial rents. J. Finance 67:1761–810 [Google Scholar]
  28. Lambrecht BM, Myers SC. 2015. The dynamics of investment, payout and debt Work. Pap., Judge Bus. Sch., Univ. Cambridge [Google Scholar]
  29. Leland HE. 1968. Saving and uncertainty: the precautionary demand for saving. Q. J. Econ 82:465–73 [Google Scholar]
  30. Leland HE. 1994. Corporate debt value, bond covenants, and optimal capital structure. J. Finance 49:1213–52 [Google Scholar]
  31. Lintner J. 1956. Distribution of incomes of corporations among dividends, retained earnings, and taxes. Am. Econ. Rev 46:97–113 [Google Scholar]
  32. Mauer DC, Triantis A. 1994. Interactions of corporate financing and investment decisions: a dynamic framework. J. Finance 49:1253–77 [Google Scholar]
  33. McDonald R, Siegel D. 1986. The value of waiting to invest. Q. J. Econ 101:707–27 [Google Scholar]
  34. Mello A, Parsons J. 1992. Measuring the agency cost of debt. J. Finance 47:1887–904 [Google Scholar]
  35. Merton RC. 1974. On the pricing of corporate debt: the risk structure of interest rates. J. Finance 29:449–70 [Google Scholar]
  36. Miao J, Wang N. 2007. Investment, consumption, and hedging under incomplete markets. J. Financ. Econ 86:608–42 [Google Scholar]
  37. Miller MH, Rock K. 1985. Dividend policy under asymmetric information. J. Finance 40:1031–51 [Google Scholar]
  38. Morck R, Yeung B, Yu W. 2000. The information content of stock markets: Why do emerging markets have synchronous stock price movements?. J. Financ. Econ 58:215–60 [Google Scholar]
  39. Morellec E. 2004. Can managerial discretion explain observed leverage ratios?. Rev. Financ. Stud 17:257–94 [Google Scholar]
  40. Morellec E, Nikolov B, Schürhoff N. 2012. Corporate governance and capital structure dynamics. J. Finance 67:803–48 [Google Scholar]
  41. Myers SC. 1977. Determinants of corporate borrowing. J. Financ. Econ 5:147–76 [Google Scholar]
  42. Myers SC. 2000. Outside equity. J. Finance 55:1005–37 [Google Scholar]
  43. Myers SC, Majd S. 1990. Abandonment value and project life. Advances in Futures and Options Research 4 F Fabozzi 1–21 Greenwich, CT: JAI Press [Google Scholar]
  44. Sannikov Y. 2008. A continuous-time version of the principal-agent problem. Rev. Econ. Stud 75:2957–84 [Google Scholar]
  45. Sannikov Y. 2013. Contracts: the theory of dynamic principal–agent relationships and the continuous-time approach. Advances in Economics and Econometrics, 10th World Congress 1 D Acemoglu, M Arellano, E Dekel 89–124 Cambridge, UK: Cambridge Univ. Press [Google Scholar]
  46. Shleifer A, Vishny RW. 1989. Management entrenchment: the case of manager-specific investments. J. Financ. Econ 25:123–39 [Google Scholar]
  47. Skinner D. 2008. The evolving relation between earnings, dividends, and stock repurchases. J. Financ. Econ 87:582–609 [Google Scholar]
  48. Stein J. 1989. Efficient capital markets, inefficient firms: a model of myopic corporate behavior. Q. J. Econ 104:655–69 [Google Scholar]
  49. Strebulaev IA, Whited TM. 2012. Dynamic models and structural estimation in corporate finance. Found. Trends Finance 6:1–163 [Google Scholar]
  50. Stulz RM. 1990. Managerial discretion and optimal financing policies. J. Financ. Econ 26:3–27 [Google Scholar]
  51. Zwiebel J. 1996. Dynamic capital structure under managerial entrenchment. Am. Econ. Rev 86:1197–215 [Google Scholar]
/content/journals/10.1146/annurev-financial-121415-032937
Loading
Agency Dynamics in Corporate Finance
Annual Review of Financial Economics 8, 53 (2016); https://doi.org/10.1146/annurev-financial-121415-032937
/content/journals/10.1146/annurev-financial-121415-032937
/content/journals/10.1146/annurev-financial-121415-032937
Loading

Data & Media loading...

  • Article Type: Review Article

Most Cited Most Cited RSS feed

This is a required field
Please enter a valid email address
Approval was a Success
Invalid data
An Error Occurred
Approval was partially successful, following selected items could not be processed due to error