Can managerial discretion explain observed leverage ratios?

Morellec, Erwan

doi:10.2139/ssrn.281535

Cited by 82 publications

(87 citation statements)

References 19 publications

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“…While our model is also applicable to public firms where managers are not diversified and sufficiently entrenched, we ignore managerial incentives (e.g., being an empire builder), which could be significant in determining capital structure decisions in public firms (Zwiebel 1996;Morellec 2004). A significant fraction of entrepreneurs view the nonpecuniary benefits of being their own bosses as a large component of rewards.…”

Section: Discussionmentioning

confidence: 99%

Entrepreneurial Finance and Nondiversifiable Risk

Chen¹,

2010

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We develop a dynamic incomplete-markets model of entrepreneurial firms, and demonstrate the implications of nondiversifiable risks for entrepreneurs' interdependent consumption, portfolio allocation, financing, investment, and business exit decisions. We characterize the optimal capital structure via a generalized tradeoff model where risky debt provides significant diversification benefits. Nondiversifiable risks have several important implications: More risk-averse entrepreneurs default earlier, but choose higher leverage; lack of diversification causes entrepreneurial firms to underinvest relative to public firms, and risky debt partially alleviates this problem; and entrepreneurial risk aversion can overturn the risk-shifting incentives induced by risky debt. We also analytically characterize the idiosyncratic risk premium. (JEL G11, G31, E20) Lack of diversification is one of the defining characteristics of entrepreneurship. Numerous empirical studies have documented that (i) active businesses account for a large fraction of entrepreneurs ' total wealth; and (ii)

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Section: Discussionmentioning

confidence: 99%

Entrepreneurial Finance and Nondiversifiable Risk

Chen¹,

2010

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“…Morellec (2004) and Leland (2007) examine the relation between the debt structure of target firms and control transactions. Morellec (2004) considers a model in which managers of target firms do not act in the best interests of shareholders. In his model debt serves as a defensive device to prevent control challenges and control transactions do not arise in equilibrium.…”

Section: Introductionmentioning

confidence: 99%

Financing and takeovers

Morellec

Zhdanov

2008

Journal of Financial Economics

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118

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This paper analyzes the interaction between financial leverage and takeover activity. We develop a dynamic model of takeovers in which the financing strategies of bidding firms and the timing and terms of takeovers are jointly determined. In the paper, capital structure plays the role of a commitment device, and determines the outcome of the acquisition contest. We demonstrate that there exists an asymmetric equilibrium in financing policies with endogenous leverage, bankruptcy, and takeover terms, in which the bidder with the lowest leverage wins the takeover contest. Based on the resulting equilibrium, the model generates a number of new predictions. In particular, the model predicts that the leverage of the winning bidder is below the industry average and that acquirers should lever up after the takeover consummation. The model also relates the dispersion in leverage ratios to various industry characteristics, such as cash flow volatility or bankruptcy costs. r

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“…A very recent paper in this direction is Morellec (2004), who uses a framework similar to Stulz (1990) and shows that managerial discretion can account for low leverage ratios.…”

Section: Literature Reviewmentioning

confidence: 99%

“…Zwiebel (1996) 33 The incumbent manager disposes special skills by which he can add value to the firm, and which are lost by his dismissal. See Morellec (2004) for a recent model. 34 see Goldstein et al (2001) 35 Recall, that µ is the drift under the risk-neutral measure Q.…”

Section: Numerical Example -Complete Informationmentioning

confidence: 99%

“…However, empirical results show that leverage levels in practice are still lower, being around 30%. 40 Goldstein et al (2001) demonstrate that lower leverage levels can be obtained when the model is extended to a dynamic capital structure setup, while Morellec (2004) tries to explain low leverage levels through the empire building desire of managers. As we will argue in a later section, low leverage levels can also be the result of an informational asymmetry between managers and investors.…”

Section: Optimal Couponmentioning

confidence: 99%

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Informational Asymmetry Between Managers and Investors in the Optimal Capital Structure Decision

Bank

Lawrenz

2005

SSRN Journal

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In this article, we consider the impact of asymmetric information between managers and investors on the optimal capital structure decision. This is done within a continuous-time framework, where the relevant state variable is given by the EBIT value of the firm; an approach taken by (2004) amongst others. Our setup differs in that we assume the EBIT to follow an Arithmetic Brownian motion, i.e. it can assume negative values. More importantly, we extend this framework in two directions: (i) We introduce a separate management claim. (ii) We introduce asymmetric information between managers and investors by assuming that claimants receive noisy signals, which they process according to rational expectation principles.Our results show, that managers always try to avoid debt, and that their optimal bankruptcy threshold is always lower, than the threshold set by equity holders. The introduction of asymmetric information changes the optimality conditions, and consequently the capital structure decision. It is shown, that the informational asymmetry can substantially lower the optimal leverage ratio, even without assuming that managers are entrenched.

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Can managerial discretion explain observed leverage ratios?

Cited by 82 publications

References 19 publications

Entrepreneurial Finance and Nondiversifiable Risk

Entrepreneurial Finance and Nondiversifiable Risk

Financing and takeovers

Informational Asymmetry Between Managers and Investors in the Optimal Capital Structure Decision

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