Summary
This line of research studies corporate capital structure, investment and payout within a managerial agency framework. Managers maximise the present value of the rents they extract from the firm subject to a threat of collective action by outside equity holders. Collective action is costly, creating space for managers to extract rents, but the governance constraint forces rents and payout to shareholders to move in lockstep. Managers share in the firm’s earnings, but outside investors’ property rights prevent managers from sharing in the proceeds from disinvestment or firm closure. This creates incentives for managers to disinvest inefficiently late.
We show that raiders or hostile acquirers can enforce efficient disinvestment or closure because they have a zero (or low) cost of collective action. Debt can also mitigate or even eliminate excessive continuation by managers because debt speeds up disinvestment. The optimal capital structure trades off expected bankruptcy costs against managerial agency costs. Firms with weaker investor protection have more debt. Managers voluntarily adopt the optimal capital structure because they capture the firm value added by a debt issue.
In related work, we assume that managers are risk averse and subject to habit formation. Shareholders are risk neutral. Managers now want to smooth rents. Payout is smooth because the governance constraint forces payout to move in lockstep with rents. Rent and payout smoothing are achieved through borrowing and saving. We show that managers’ optimal rent and payout policy follows the famous Lintner (1956) dividend partial adjustment model. In our model payout adjusts partially and gradually in response to income shocks. The partial adjustment coefficient is determined by managers’ internal habit formation coefficient. Payout and rents are determined by permanent income. Transitory income shocks have little effect on payout. The Lintner (1956) model, while tested extensively in empirical work, had never been derived in any formal setting. Our work therefore provides a theoretical framework for Lintner’s dividend model. A related paper introduces taxes and allows investment to vary. We show that managers’ utility function has important implications for capital structure. Depending on their preferences managers may adopt a target net debt ratio or follow a pecking order style financing policy.
Lambrecht, B.M. and Myers, S.C. (2017) “The dynamics of investment, payout and debt.” Review of Financial Studies (forthcoming) (available online via the SSRN)
Lambrecht, B.M. and Myers, S.C. (2016) “Agency dynamics in corporate finance.” Annual Review of Financial Economics, 8: 53-80 (DOI: 10.1146/annurev-financial-121415-032937)
Lambrecht, B.M. and Myers, S.C. (2012) “A Lintner model of payout and managerial rents.” Journal of Finance, 67(5): 1761-1810 (DOI: 10.1111/j.1540-6261.2012.01772.x)
Lambrecht, B.M. and Myers, S.C. (2008) “Debt and managerial rents in a real-options model of the firm.” Journal of Financial Economics, 89(2): 209-231 (DOI: 10.1016/j.jfineco.2007.07.007)
Lambrecht, B.M. and Myers, S.C. (2007) “A theory of takeovers and disinvestment.” Journal of Finance, 62(2): 809-845 (DOI: 10.1111/j.1540-6261.2007.01224.x)