The Disciplining Role of External Financing

Abstract

Managers raise financing (do not raise financing) when the benefit of financing exceeds (is less than) the cost of raising financing. Using this intuition, I develop a method to extract the benefits and costs of raising financing by observing the financing decisions managers actually make. Consistent with agency conflicts in financing choices, the estimates show that poorly governed managers receive benefits from external financing not shared by well governed managers. However, the estimates also show that the costs are different for poorly governed managers and well governed managers. The surprising finding is that the difference in costs offsets the difference in benefits. This allows me to conclude that external financing helps discipline managers.