Working Paper: CEPR ID: DP9926
Authors: Bart Lambrecht; Stewart C. Myers
Abstract: We present a dynamic agency model of investment, borrowing and payout decisions by a mature corporation operating in perfect financial markets. Risk-averse managers implement an inter-temporal strategy that maximizes their lifetime utility of managerial rents. They under-invest and smooth payout and rents. Debt is the shock-absorber for operating income and investment. Managers do not rebalance capital structure, so shocks to debt levels persist. Managers implement precautionary savings by paying down debt, even when interest is tax-deductible. We generate empirical predictions that differ from conventional agency models and from dynamic models based on financing frictions.
Keywords: agency; financing; policy; investment; payout
JEL Codes: G31; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| managers' risk aversion (D81) | underinvestment (G31) |
| personal rate of time preference (D15) | rents (R21) |
| precautionary savings (D14) | reduced corporate borrowing (G32) |
| debt (H63) | absorbs volatility in operating income (G32) |
| higher debt levels (H63) | discipline managers (Y80) |
| payout smoothing (G35) | optimizing behavior in dynamic agency context (L21) |