On the relation between ownership structure and capital structure

Abstract

The agency relationship between managers and shareholders has the potential to influence decision-making in the firm which in turn potentially impacts on firm characteristics such as value and leverage. Prior evidence has demonstrated an association between ownership structure and firm value. This paper extends the literature by examining a further link between ownership structure and capital structure. Using an agency framework, it is argued that the distribution of equity ownership among corporate managers and external blockholders may have a significant relation with leverage. The empirical results provide support for a positive relation between external blockholders and leverage, and non-linear relation between the level of managerial share ownership and leverage. The results also suggest that the relation between external block ownership and leverage varies across the level of managerial share ownership. These results are consistent with active monitoring by blockholders, and the effects of convergence-of-interests and management entrenchment.

Ownership, capital structure and financing decision: Evidence from the UK

“…On the other hand, Zwiebel (1996) proposes that self-interested managers will decrease debt levels to avoid the disciplining role of debt and the threat of a bankruptcy. Since managers bear non-diversifiable employment risk linked to firm survival, bankruptcy or financial distress will result in their demotion or loss of employment (Brailsford et al, 2002;Friend and Lang, 1988). In this context, risk-averse managers are more reluctant to raise firm debt levels to protect their undiversified human capital.…”

“…According to two competing theories, interest alignment theory (Jensen and Meckling, 1976) and managerial entrenchment theory (Fama and Jensen, 1983), some studies find a curvilinear relation between MSO and leverage (e.g., Brailsford et al, 2002;Florackis and Ozkan, 2009). …”

“…However, when MSO surpasses a "changeover" point, managers have more discretion adjusting debt levels in their own interest 7 (Brailsford et al, 2002). Such entrenched managers have more incentive to lower firm debt levels, to avoid the pressure of interest payment commitments (Jensen, 1986), and to reduce bankruptcy risk and the associated loss of entrenchment (Zwiebel, 1996).…”

“…Third, high debt levels correspond to a high risk of financial distress and bankruptcy. Since managers bear non-diversifiable employment risk linked to firm survival, bankruptcy or financial distress will result in their demotion or loss of 8 employment (Brailsford et al, 2002;Friend and Lang, 1988). In other words, when loss of control is less of a concern, firms are more likely to fund their growth with equity issues.…”

“…Proper management of firm ownership structure can have a significant effect on firm leverage levels, echoing the argument of Brailsford et al (2002), Florackis and Ozkan (2009), and Friend and Lang (1988). Such an effect is generally imposed via a firm's external financing activities, since, in practice, security issues and proceeds are used to directly affect capital structure.…”