Determinants of Leverage and Agency problems

In this paper we empirically investigate the determinants of leverage and agency problems and we examine the relationships between leverage and agency problems. As in Titman and Wessels (1988) we use structural equations modeling with latent variables. In contrast to Titman and Wessels (1988), who employ data obtained from annual reports and capital markets, we use questionnaire data to measure firm characteristics. The questions concern the characteristics of the respondents’ firms, including the presence of agency problems. We estimate the relations between these characteristics. The results confirm that the trade-off between tax advantages and bankruptcy costs determines leverage. We also find free cash flow and corporate governance characteristics as determinants of overinvestment. Despite findings that agency problems are present, direct relationships between leverage and four agency problems are absent.