Takeover Defenses, Managerial Ownership, and Firm Leverage

Abstract

We examine the impact of the agency conflicts of debt on firm financing decision. Consistent with the hypothesis that firm financing policy is determined by the tradeoff between the market for corporate control (takeover defenses) and managerial opportunism, we find that managerial equity ownership and its interaction with takeover defenses affect firm financing decisions. Specifically, we find that (i) firms with large takeover defenses carry high levels of debt, (ii) firms with large managerial ownership operate at high levels of debt unless the firm has a large number of takeover defenses, in which case these managers reduce debt levels, and (iii) the relation between leverage and takeover defenses becomes insignificant when we control for the interaction between these defenses and managerial ownership. Further testing reveals that while bond covenants have a role in reducing the agency conflicts related to the cost of debt financing, they have an insignificant role related to firm leverage. Overall, the evidence suggests that a two-dimensional aspect of governance that includes the interaction between managerial ownership and takeover defenses is imperative in understanding the impact of the agency costs on firm financing decisions.