Essays on investor-manager conflict and corporate financial decision-making

This thesis examines the role of financial policy in resolving investment conflicts between investors and managers. The method of analysis is an analytical one. The thesis first surveys two areas of research: agency-theoretical studies of corporate capital investment and capital structure theories. The main body of the thesis consists of three essays in which various capital budgeting situations are modelled and different aspects of corporate financial policy are analysed. Essay one models an investment problem of a multiple division firm and shows that capital rationing can be used to force managers to compete for investment capital and therefore reduce their incentive to shirk. The main result is that, if a firm’s investment opportunities are not highly profitable, investors may be better off with capital rationing even though rationing forces the firm to forgo some profitable projects. Essay two demonstrates that direct compensation may be ineffective in providing proper managerial incentives in the presence of the limited liability condition but managerial stock acquisition can be useful instead. The signalling and screening forms of contracting for stock acquisition are analysed and then compared. The analysis provides an explanation for the existence of insider stock ownership. Essay three considers situations where external monitoring is required to discipline managers. The need for monitoring changes the structure of corporate ownership and alters the nature of agency conflict. Within this context, debt is shown to be useful in improving firms’ investment efficiency because of its risk-shifting effect. Implications and empirical evidence are discussed at the end.Business, Sauder School ofGraduat