Showing papers on "Agency cost published in 1986"

Agency Costs, Collateral, and Business Fluctuations

Abstract: Bad economic times are typically associated with a high incidence of financial distress, e.g., insolvency and bankruptcy. This paper studies the role of changes in borrower solvency in the initiation and propagation of the business cycle. We first develop a model of the process of financing real investment projects under asymmetric information, extending work by Robert Townsend. A major conclusion here is that when the entrepreneurs who borrow to finance projects are more solvent (have more "collateral"), the deadweight agency costs of investment finance are lower. This model of investment finance is then embedded in a dynamic macroeconomic setting. We show that, first, since reductions in collateral in bad times increase the agency costs of borrowing, which in turn depress the demand for investment, the presence of these financial factors will tend to amplify swings in real output. Second, we find that autonomous factors which affect the collateral of borrowers (as in a "debt-deflation") can actually initiate cycles in output.

Agency Costs, Collateral, and Business Fluctuations

Abstract: Bad economic times are typically associated with a high incidence of financial distress, e.g., insolvency and bankruptcy. This paper studies the role of changes in borrower solvency in the initiation and propagation of the business cycle. We first develop a model of the process of financing real investment projects under asymmetric information, extending work by Robert Townsend. A major conclusion here is that when the entrepreneurs who borrow to finance projects are more solvent (have more "collateral"), the deadweight agency costs of investment finance are lower. This model of investment finance is then embedded in a dynamic macroeconomic setting. We show that, first, since reductions in collateral in bad times increase the agency costs of borrowing, which in turn depress the demand for investment, the presence of these financial factors will tend to amplify swings in real output. Second, we find that autonomous factors which affect the collateral of borrowers (as in a "debt-deflation") can actually initiate cycles in output.

The Impact of Preferred‐for‐Common Exchange Offers on Firm Value

Abstract: This paper examines the impact of capital structure changes which have no corporate tax consequences. Specifically, exchange offers involving preferred and common stock are analyzed. We find that systematic changes in firm value occur when companies announce preferred-for-common exchange offers. Consequently, we interpret our results to be consistent with a signalling hypothesis. We also find weaker evidence suggesting the existence of agency cost effects or wealth redistributions across security classes. Our findings imply that capital structure changes need not alter the tax status of the issuing firm to affect firm value. SINCE THE ORIGINAL MODIGLIANI-MILLER [28] irrelevance proposition, numerous hypotheses have evolved which attempt to explain why capital structure decisions may be of consequence to the securityholders of a firm. Each of these hypotheses posits the existence of one or more capital market imperfections. Such imperfections include corporate and personal taxes or bankruptcy costs [10, 14, 26], unequal access or imperfect substitutes [11], asymmetric information [15, 30, 31, 33], and agency costs [13, 29, 35]. Because the significance of such imperfections in the "real world" is unknown, the relevance of capital structure decisions becomes an empirical issue. Recent empirical studies suggest that capital structure decisions impact firm value. Masulis [19-22], Dann [8], Vermaelen [36], McConnell and Schlarbaum [18], Mikkelson [24], Dann and Mikkelson [9], Masulis and Korwar [23], Asquith and Mullins [1], and Mikkelson and Partch [25] all document statistically significant security price movements in response to leverage-related, firm-specific events.' These studies suggest the existence of market imperfections which make capital structure decisions relevant. However, which imperfections, singly or in combination, are driving the results is still unresolved. Masulis [22] argues that the observed returns are attributable to a tax effect, a redistribution effect or a tax-based information effect. With the exception of Mikkelson [24], who leaves the question open, the other authors argue that signalling or agency cost effects dominate the tax effect.

Agency Costs and the Agricultural Firm

Abstract: In the last decade, there has been a major rekindling of interest among economists in the form of institutions used to organize resources for production and distribution. Jensen (1983) distinguishes two "agency literatures" that share the comparative institutions perspective introduced by Coase (1937, 1960). Principal agency theory (e.g., Stiglitz 1975; Harris and Raviv 1978; Shavell 1979; H61mstrom 1979; Lewis 1980) provides a mathematical formulation of contractual choice and has been primarily directed to the trade-off between risksharing and incentives against labor shirking. Positive agency theory (pioneered by Coase 1937; resurrected by Alchian and Demsetz 1972; and currently represented, for example, by Fama and Jensen 1983a) is nonmathematical and places relatively more emphasis on explaining actual patterns that characterize industrial organization. In agriculture, the theory of organizational form has centered largely around tenure choice. The theory of tenure choice has an illustrious history in the economics literature (e.g., Smith 1922; Marshall 1920; Heady 1955; Day 1967; Cheung 1969; Rao 1971; Stiglitz 1974; Reid 1976; Newbery and Stiglitz 1979; Binswanger and Rosenzweig 1984). In recent years, alternative tenancy arrangements are commonly viewed as types of employment contracts (e.g., Newbery and Stiglitz 1979; Braverman and Stiglitz 1975; Harris and Raviv 1978; Shavell 1979; HW1mstrom 1979; Lewis 1980). In an innovative departure from the view of tenancy as an employment contract, Eswaran and Kotwal (1985) have modelled share tenancy as a partnership between a landowner who specializes in decision-making and a tenant who specializes in labor supervision. More generally, questions of tenure choice, employment contracts, manag ment systems, and farm size can all be usefully viewed as aspects of agricultural organization. The purpose of the present paper i to elucidate this view and to investigate tenure choice as a part of the general study of the nature and causes of the agricultural firm. The paper is organized to highlight the inductive approach employed. Section 2 classiies agricultural firms according to the degree of specialization and who gets the residual payment. The classification is combined with previously documented patterns of tenure choice in order to posit a preliminary hypothesi about the relationship between the econo ic environment and the nature of the agricultural firm. Section 3 uses a principalagency framework to construct a theory of the hypothesized relationship between the degree of separation between labor and management nd l nd quality. Section 4 provides an illustrative statistical verification of the hypothesis based on a sample of Philippine sugarcane f rms. Section 5 summarizes the paper and discusses two implications of the transaction cost approach for institutional design.

The Role of Options in the Resolution of Agency Problems: A Comment

Abstract: THE AIM OF THE contracting literature in economics is to explain observed contractual arrangements, or organizations, as minimizing the costs of incentive conflicts. In the agency cost literature of financial economics, the contractual arrangement at issue is the mix of securities held by inside management of a firm and outside suppliers of capital-the ownership structure of the firm, in Jensen and Meckling's [8] terminology. In explaining the ownership structure of a corporation, Jensen and Meckling focus on two sources of agency or incentiveconflict costs: (a) the manager's tendency to consume excessive perquisites, and (b) the manager's tendency to invest in prospects of high risk so as to effect an ex post transfer from bondholders to stockholders. A recent article in this journal by Haugen and Senbet [61 examines the role of stock options in resolving these agency problems and claims to show, in particular, that a call option in the insider portfolio can eliminate the first type of agency costs. This article re-examines the role of options in the resolution of agency problems. We argue, in Section I, that options cannot eliminate the agency problem of excessive perquisite consumption, contrary to Haugen and Senbet. The essential point is that unless outside financing can be provided entirely by riskless debt, then outsiders must have a residual claim on the net income of the firm in some states of the world. Outsiders therefore share in the costs of increased perquisite consumption, whatever the ownership structure of the firm. This negative externality means that excessive perquisite consumption is inevitable. The question remains: Do call options nonetheless have a role in the mitigation of agency costs? An insider portfolio consisting only of equity leaves the manager with the same proportion of residual claim in each state of the world. We show, using a formal principal-agent model, that the efficient insider's share of profits is relatively high in favorable (high-profit) states of the world. Insider call options arise as means of transferring residual claim to the manager in favorable states of the world relative to low-profit states. The basic agency model has been solved in substantial generality by Holmstrom [7] and others. We employ here a more specific model that draws on the techniques developed by Green and Kahn [4] and that is an extension to continuous states of the finite-state model of Sappington [12]. The extension allows a simple characterization of the optimal contract, a characterization that

The Effect of Management's Choice between Negotiated and Competitive Equity Offerings on Shareholder Wealth

Abstract: This paper investigates the effect on shareholder wealth of two events that change management's choice between negotiated and competitive underwritten equity offerings. These two events are the suspension and termination of suspension of Rule 50. (This rule is based on the Public Utility Holding Company Act of 1935 and requires certain utilities to use the competitive method.) The results indicate that the shareholders of the affected utilities experience an abnormal negative return on the announcement of the suspension of Rule 50, and an abnormal positive return on the announcement of the termination of suspension. This evidence is consistent with the joint hypothesis: (i) competitive offerings are less costly than negotiated offerings, and (ii) manager-shareholder agency costs are a determinant of the corporate choice between these two methods of raising equity.

Shareholder bonding in financial mutuals: An exploratory study of the relative effects of altruism and agency

Abstract: It is argued that cooperatives allow for the increased use of more informal methods of control than those found in non-cooperative organizations. The extent to which these informal controls can be utilized may depend on the strength of shareholder bonding, the determinants of which are, inter alia , peer group pressure and altruism. Peculiar cooperative organizational arrangements might be associated with differential agency costs, however formal recognition of the role of altruism in economic behaviour provides a direct alternative to agency theory.

Agency Costs, Collateral, and Business Fluctuations

Abstract: Bad economic times are typically associated with a high incidence of financial distress, eg, insolvency and bankruptcy This paper studies the role of changes in borrower solvency in the initiation and propagation of the business cycle We first develop a model of the process of financing real investment projects under asymmetric information, extending work by Robert Townsend A major conclusion here is that when the entrepreneurs who borrow to finance projects are more solvent (have more "collateral"), the deadweight agency costs of investment finance are lower This model of investment finance is then embedded in a dynamic macroeconomic setting We show that, first, since reductions in collateral in bad times increase the agency costs of borrowing, which in turn depress the demand for investment, the presence of these financial factors will tend to amplify swings in real output Second, we find that autonomous factors which affect the collateral of borrowers (as in a "debt-deflation") can actually initiate cycles in output

On defining the agency costs of debt

Abstract: Since Jensen and Meckling [1976] first introduced the concept of an agency cost of debt, most research on the agency cost of debt has centered on who bears these costs. Jensen and Meckling's original contention was that if bondholders have rational expectations, then the owner‐manager should bear the agency costs of debt. The alternative to this explanation was first offered by Barnea, Haugen and Senbet [1981] who claimed that because of the effects of agency costs on the supply of debt, these costs would be borne by the bondholders. Roberts and Viscione [1984] extend the analysis of Barnea, Haugen, and Senbet by including costly tax avoidance on personal and corporate levels to show that the agency costs of debt are shared by bondholders and owner‐managers.

Mergers and Investment Incentives

Abstract: This paper explores the effects of mergers on the investment incentives of the levered firm and on levered firm value. Under a fairly broad set of assumptions, it is shown that most firm combinations "improve" investment incentives, bringing about a reduction in the agency costs of underinvestment associated with risky debt. The effect of the merger on debt and equity claim values is also explored. If not properly anticipated, the merger may create a wealth transfer from equity holders to bondholders. Such a wealth transfer in? cludes, but is not limited to, the "coinsurance effect."