Are Debt and Incentive Compensation Substitutes in Controlling the Free Cash Flow Agency Problem?

Yilei Zhang

Financial Management, 2009, vol. 38, issue 3, 507-541

Abstract: This paper investigates the governance implications of a firm's capital structure and managerial incentive compensation in controlling the free cash flow agency problem. The results suggest: debt and executive stock options act as substitutes in attenuating a firm's free cash flow problem; failure to incorporate the substitutability and endogeneity leads to underestimates of the magnitude and economic implication of the disciplinary role of both mechanisms; firm characteristics differ across the prevalence of debt usage versus option usage, suggesting the heterogeneity in the costs and benefits of the monitoring devices; and all the above effects are more pronounced in firms that tend to have more severe agency problem.

Date: 2009
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https://doi.org/10.1111/j.1755-053X.2009.01046.x

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