Is Leverage Effective in Increasing Performance Under Managerial Moral Hazard?

R. Calcagno

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Abstract

We consider a model in which the principal-agent relation between inside shareholders and the management affects the firm value.We study the effect of financing the project with risky debt in changing the incentive for a risk-neutral shareholder (the principal) to implement the project-value maximizing contract.We show the conditions under which leverage generates agency costs in terms of an ex-ante reduction of the firm value.The result also implies that the optimal remuneration structure includes "low-incentive" bonus when the firm is highly leveraged.This inefficiency does not arise when the the agent is paid with shares of the firm.We can then conclude that the use of debt is effective as a commitment device to implement higher operative performance only if it is accompanied with a compensation policy based on shares remuneration.
Original languageEnglish
Place of PublicationTilburg
PublisherFinance
Number of pages32
Volume2000-101
Publication statusPublished - 2000

Publication series

NameCentER Discussion Paper
Volume2000-101

Keywords

  • corporate performance
  • management
  • moral hazard
  • capital structure
  • incentives
  • agency theory

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  • Cite this

    Calcagno, R. (2000). Is Leverage Effective in Increasing Performance Under Managerial Moral Hazard? (CentER Discussion Paper; Vol. 2000-101). Finance.