(Georgia Institute of Technology, 2006-07-10)
Fu, Jinyi
We examine the financing choices of undiversified large shareholders or owner-managers in a continuous time structural model with rational expectations. The interplay between the objective of the undiversified, self-interested owner-manager who controls the firm and the valuation of the firms marketed claims by well-diversified outside investors, has a major impact on leverage and debt maturity choices as well as credit spreads. The effect of this interplay is particularly significant in a world where the representative investor (who determines asset prices in the economy) is risk-averse leading to nonzero market prices of systematic risk and risk premia of the firms investment opportunities. In a perfect information framework with no taxes or bankruptcy costs, we show that, the owner-manager could, depending on the projects characteristics, finance them exclusively with debt, exclusively with equity, or with a combination of equity and debt. Ceteris paribus, leverage increases with the expected growth rate of firm value under its investment opportunities, and decreases with its volatility. Debt maturity varies non-monotonically in a U-shaped manner with the expected growth rate, and decreases with the volatility. Our results reconcile empirical evidence on the variation of financing choices with firm characteristics that is not completely consistent with previous theories. The significant impact of the expected returns (therefore, risk premia) of firms investment opportunities on their leverage ratios, debt maturities, and credit spreads are important implications of our theory that cannot be obtained in these models or in models in which all agents are risk-neutral so that risk premia are zero. We empirically test the implications of our theory for the relationships among firms financing and debt maturity choices and the expected growth rate and volatility of their asset values. Controlling for all the significant determinants of firms financing and debt maturity choices identified by earlier studies, we show significant empirical support for our predictions.
(Georgia Institute of Technology, 2006-07-07)
Gilson, Paul W. R.
My study examines the relationship between principal and agent in a moral hazard setting where the principal has the ability to monitor the actions of the agent at an interim stage of the project. I show that monitoring can induce the agent to exert higher levels of effort and can result in a reallocation of project payoffs between the two parties. This reallocation is not a one-way street: Situations exist where monitoring encourages greater effort from the agent, resulting in greater project payoffs for both principal and agent. For projects that are characterized as high-risk, high-reward projects where agent involvement is costly, monitoring is often the optimal strategy; this is an explanation for why venture capital type investments are the subject of intense monitoring. When the principal can share monitoring results at an interim stage with the agent, the agent is able to modify his effort levels in certain situations for the benefit of both parties.