Disentangling the incentive and entrenchment effects of large shareholdings
- Claessens, Stijn, Simeon Djankov, Joseph Fan, Larry H.P. Lang
- Journal of Finance,
This paper conducts powerful new tests of whether debt can mitigate the effects of agency and information problems. We analyze emerging market firms for which pyramid ownership structures create potentially extreme managerial agency costs. Our tests incorporate both traditional financial statement data and new data on global debt contracts. Our analysis is mindful of the potential endogeneity between debt, ownership structure, and value, and takes into account differences in the debt capacity of a firm’s assets in place and future growth opportunities. The results indicate that the incremental benefit of debt is concentrated in firms with high expected managerial agency costs that are also most likely to have overinvestment problems resulting from high levels of assets in place or limited future growth opportunities. Subsequent internationally syndicated term loans are particularly effective at creating value for these firms. Our results support the recontracting hypothesis that shareholders value compliance with monitored covenants, particularly when firms are likely to overinvest. We wish to thank Ian Domowitz, John Graham, Ravi Jagannathan, Narayanan Jayaraman, Mike Lemmon, John McConnell, Ned Prescott, William Schwert, Daniel Wolfenzon, an anonymous referee, and participants at the Second Annual CIFRA International Finance Conference at London Business School, the 2003 meetings of the American Finance Association, the Seventh Annual Georgia Tech International Finance Conference, the Federal Reserve Bank of Atlanta’s Conference on Finance and Growth, and seminars at the University of Utah, the University of Virginia, and the University of Washington for helpful comments and suggestions. Email correspondence may be directed to Harvey at email@example.com, Lins at firstname.lastname@example.org, or Roper at email@example.com.