Optimal capital structure and the debtholder-manager conflicts of interests: a management decision model

Adeoye, Olanike Akinwunmi, Islam, Sardar MN., and Adekunle, Adeshina Israel (2021) Optimal capital structure and the debtholder-manager conflicts of interests: a management decision model. Journal of Modelling in Management, 16 (4). pp. 1070-1095.

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Abstract

Purpose:

Determining the optimal capital structure becomes more complicated by the presence of an agency problem. The issuance of debt as a corporate governance mechanism introduces the asset substitution problem - the agency cost of debt. Thus, there is a recognized need for models that can resolve the agency problem between the debtholder and the manager who acts on behalf of the shareholder, leading to optimal capital structure choice, and enhanced firm value. The purpose of this paper is to model the debtholder-manager agency problem as a dynamic game, resolve the conflicts of interests and determine the optimal capital structure.

Design/methodology/approach:

As there is no satisfactory model for dealing with the above issues, this paper uses a differential game framework to analyze the incongruity of interests between the debtholder and the manager as a non-cooperative dynamic game and further resolves the conflicts of interests as a cooperative game via a Pareto-efficient outcome.

Findings:

The optimal capital structure required to minimize the marginal cost of the agency problem is a higher use of debt, lower cost of equity and withheld capital distributions. The debtholder is also able to enforce cooperation from the manager by providing a lower and stable cost of debt and a greater debt facility in the overtime framework.

Originality/value:

The study develops a new dynamic contract theory model based on the integrated issues of capital structure, corporate governance and agency problems and applies the differential game approach to minimize the agency problem between the debtholder and the manager.

Item ID: 66180
Item Type: Article (Research - C1)
ISSN: 1746-5672
Keywords: Finance, Optimization, Strategy, Simulation
Copyright Information: © Emerald Publishing Limited
Date Deposited: 30 Dec 2020 07:44
FoR Codes: 38 ECONOMICS > 3803 Economic theory > 380302 Macroeconomic theory @ 50%
49 MATHEMATICAL SCIENCES > 4903 Numerical and computational mathematics > 490304 Optimisation @ 50%
SEO Codes: 15 ECONOMIC FRAMEWORK > 1502 Macroeconomics > 150209 Savings and investments @ 50%
15 ECONOMIC FRAMEWORK > 1503 Management and productivity > 150302 Management @ 50%
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