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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
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/content/journals/10.1146/annurev-financial-121415-032937
2016-10-23
2024-04-23
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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
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