A model of dynamic compensation and capital structure

Zhiguo He ()

Journal of Financial Economics, 2011, vol. 100, issue 2, 351-366

Abstract: This paper studies the optimal compensation problem between shareholders and the agent in the Leland (1994) capital structure model, and finds that the debt-overhang effect on the endogenous managerial incentives lowers the optimal leverage. Consistent with data, our model delivers a negative relation between pay-performance sensitivity and firm size, and the interaction between debt-overhang and agency issue leads smaller firms to take less leverage relative to their larger peers. During financial distress, a firm's cash flow becomes more sensitive to underlying performance shocks due to debt-overhang. The implications on credit spreads and debt covenants are also considered.

Keywords: Continuous-time; contracting; Capital; structure; CARA; (exponential); preference; Firm; growth; Size-heterogeneity; Pay-performance; sensitivity (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (48)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:100:y:2011:i:2:p:351-366

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