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

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.

Prioritizing factors for effective strategy implementation in small and medium-size organizations

“…This is supported by Kohtamäki et al (2022) and Minshull et al (2022), who indicated that commitment bridges the gap between planning and execution. We consider it pertinent to add that OC supports ESI execution and reduces the risks associated with the absence of coordination mechanisms (Martinez-Lozada and Espinosa, 2022; Adeoye et al , 2021).…”

“…In the SME context, this could restrict the quality of operations and the ability to adopt innovations. Thus, in the context of our work, we contend that regardless of the complexity of a strategy, it should be accompanied by simple communication, as it is often more effective in influencing different groups and levels of an organization and does not exclusively depend on individuals’ degree of involvement (Adeoye et al , 2021).…”

“…The above review briefly introduced some approaches to investigating ESI from a systemic perspective. In this sense, Paucar-Caceres et al (2022) indicated that the most frequently used tools include SSM (Checkland, 2001), the viable system model (Martinez-Lozada and Espinosa, 2022), system dynamics (Sánchez-García et al , 2023), network analysis and multicriteria methods (Saaty, 2004; Adeoye et al , 2021; Jaiswal et al , 2021). In this context, SSM has been helpful as a heuristic for identifying significant actors in terms of ESI, secondary but necessary actors, and uncovering pathological relationships to build a mental model of how a change in pathological relationships can be generated (Núñez-Ríos et al , 2022).…”

“…This study addresses small- and medium-sized enterprises (SMEs) and engages the effective strategy implementation (ESI) and systemic approach domains (Adeoye et al , 2021). We seek to identify factors supporting ESI in interactions between management and associated control mechanisms (Sánchez-García et al , 2023).…”

“…This is supported byKohtamäki et al (2022) andMinshull et al (2022), who indicated that commitment bridges the gap between planning and execution. We consider it pertinent to add that OC supports ESI execution and reduces the risks associated with the absence of coordination mechanisms (Martinez-Lozada and Espinosa, 2022;Adeoye et al, 2021).Plan development was the second relevant factor, indicating that participants consider management initiatives paramount for ESI. LikePham et al (2021), we consider this factor paramount for applying strategy under clear organizational principles.…”