Working Paper: NBER ID: w11083
Authors: Andrew Atkeson; Harold L. Cole
Abstract: We put forward a theory of the optimal capital structure of the firm based on Jensen's (1986) hypothesis that a firm's choice of capital structure is determined by a trade-off between agency costs and monitoring costs. We model this tradeoff dynamically. We assume that early on in the production process, outside investors face an informational friction with respect to withdrawing funds from the firm which dissipates over time. We assume that they also face an agency friction which increases over time with respect to funds left inside the firm. The problem of determining the optimal capital structure of the firm as well as the optimal compensation of the manager is then a problem of choosing payments to outside investors and the manager at each stage of production to balance these two frictions.
Keywords: optimal capital structure; executive compensation; agency costs; monitoring costs; dynamic contracting
JEL Codes: G3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| agency costs (G34) | capital structure (G32) |
| monitoring costs (Q52) | capital structure (G32) |
| capital structure (G32) | executive compensation (M12) |
| agency costs (G34) | executive compensation (M12) |
| monitoring costs (Q52) | executive compensation (M12) |
| executive compensation (M12) | capital structure (G32) |