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/lp/annual-reviews/agency-dynamics-in-corporate-finance-cWynl4kUgt
- Publisher
- Annual Reviews
- Copyright
- Copyright © 2016 by Annual Reviews. All rights reserved JEL codes: G31, G32
- ISSN
- 1941-1367
- eISSN
- 1941-1375
- DOI
- 10.1146/annurev-financial-121415-032937
- Publisher site
- See Article on Publisher Site
Abstract
We describe a framework for analyzing the dynamics of investment, borrowing, and payout decisions by public corporations. We assume that managers act entirely in their own long-run interests, subject to a governance constraint that limits their rents. Risk-neutral managers invest to maximize value but wait too long to disinvest. Efficient disinvestment can be forced by the right level of debt or by takeovers. Risk-averse managers underinvest; they do not waste free cash flow, because the governance constraint is binding. They smooth rents and consequently payout, so that changes in borrowing become a shock absorber for volatility of operating income. We obtain the Lintner model of payout if risk-averse managers have a utility function with habit formation. We show how to adapt the dynamic framework to analyze several other issues, including the effects of asymmetric information. We show that Lintner-style payout smoothing can also arise when risk-neutral managers are better informed than outsiders.
Journal
Annual Review of Financial Economics – Annual Reviews
Published: Oct 23, 2016