Managerial Discretion and the Capital Structure Dynamics

Abstract

This paper examines the effect of managerial discretion on capital structure dynamics. Analyses of financing decisions indicate that managers with more discretion prefer issuing equity over debt. Examination of leverage changes suggests that increases in debt ratios due to positive and negative financial deficits are greater for managers with high discretion. Furthermore, when managers have high‐ discretion, debt changes seem to be more sensitive to issuance activities than to repurchase activities. For high‐discretion managers, market timing activities (equity issuance following increases in stock prices) and the passive response to stock price appreciations, result in greater declines in debt ratios. Finally, while firms tend to rebalance their capital structures over time regardless of the level of managerial discretion, the speed of target adjustment is much slower for high‐discretion managers.