Long‐term Investments and Financial Structure

Noriyuki Yanagawa

International Review of Finance, 2000, vol. 1, issue 1, 39-51

Abstract: This paper examines how the financial structure of a firm affects the incentives of managers to act myopically. The paper shows that managers tend to choose investments that pay off too quickly if there is a possibility that shareholders will fire the managers in the future. However, this problem can be avoided if firms are appropriately financed. Since the gains from firing the managers accrue first to the creditors, the shareholders’ incentive to fire the managers is reduced when the firm increases its debt ratio. The firm should thus choose an optimal financial structure to ensure that the level of incentive for shareholders to dismiss managers is appropriately controlled.

Date: 2000
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