A Dynamic Theory of Optimal Capital Structure and Executive CompensationHarold Cole () and Andrew Atkeson No 267, 2004 Meeting Papers from Society for Economic Dynamics Abstract: In this paper, we put forward a theory of the optimal capital structure of the firm based on Jensen's (1986) hypothesis that a firm's choice of capital structure is determined by a trade-off between agency costs and monitoring costs. The problem of determining the optimal capital structure of the firm as well as the optimal compensation of the manager is then a problem of choosing payments to outside investors and the manager at each stage of production to balance these two frictions. Our theory has the following implications regarding optimal capital structure and executive compensation. Each period, the payouts from the firm can be divided into payments to the manager that consist of a non-contingent base pay and a performance component of pay based on the realized output of the firm, and two distinct payments to the outside investors that resemble payments debt and outside equity respectively. In our model, the dynamics of the capital structure come from the dynamics of compensation Keywords: outside debt and equity; base pay; performance bonus; golden parachutte (search for similar items in EconPapers) There are no downloads for this item, see the EconPapers FAQ for hints about obtaining it. Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: http://EconPapers.repec.org/RePEc:red:sed004:267 Access Statistics for this paper More papers in 2004 Meeting Papers from Society for Economic Dynamics |
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