This article analyzes the impact of managerial discretion and corporate control mechanisms on leverage and firm value within a contingent claims model where the manager derives perquisites from investment. Optimal capital structure reflects both the tax advantage of debt less bankruptcy costs and the agency costs of managerial discretion. Actual capital structure reflects the trade-off made by the manager between his empire-building desires and the need to ensure sufficient efficiency to prevent control challenges. The model shows that manager-shareholder conflicts can explain the low debt levels observed in practice. It also examines the impact of these conflicts on the cross-sectional variation in capital structures.

[Most firms face some form of competition in product markets. The degree of competition a firm faces feeds back into its cash flows and affects the values of the securities it issues. Through its effects on stock prices, product market competition affects the prices of options on equity and leads to an inverse relationship between equity returns and volatility, generating a negative volatility skew in option prices. Using a large sample of U.S. equity options, we provide empirical support for this finding and demonstrate the importance of accounting for product market competition when explaining the cross-sectional variation in option skew.]

[In this paper we examine the effects of capital gains taxation on firms' investment and financing decisions. We develop a real-options model in which the timing of investment, the decision to default, and the firm's capital structure are endogenously and jointly determined. Our analysis demonstrates that the asymmetric taxation of capital gains and losses fosters investment by eroding the option value of waiting. It also shows that firms controlled by taxable investors employ more equity financing, the higher the firm's stock price and the worse the firm's historical performance. Using a large sample of U.S. industrial firms that are owned by taxable investors between 1970 and 2008, we present new evidence on corporate investment and financing policies, which is supportive of the model's predictions.]

We develop a dynamic model of investment, financing, and cash management decisions in which investment is lumpy and firms face capital supply uncertainty. We characterize optimal policies explicitly, demonstrate that smooth-pasting conditions may not guarantee optimality, and show that firms may not follow standard single barrier policies. In the model, firms with high investment costs differ in their behaviors from firms with low investment costs, financing policy does not follow a strict pecking order, and the optimal payout policy may feature several regions with both incremental and lumpy dividend payments.

This article analyzes the impact of managerial discretion and corporate control mechanisms on leverage and firm value within a contingent claims model where the manager derives perquisites from investment. Optimal capital structure reflects both the tax advantage of debt less bankruptcy costs and the agency costs of managerial discretion. Actual capital structure reflects the trade-off made by the manager between his empire-building desires and the need to ensure sufficient efficiency to prevent control challenges. The model shows that manager-shareholder conflicts can explain the low debt levels observed in practice. It also examines the impact of these conflicts on the cross-sectional variation in capital structures.

In this paper we examine the effects of capital gains taxation on firms' investment and financing decisions. We develop a real-options model in which the timing of investment, the decision to default, and the firm's capital structure are endogenously and jointly determined. Our analysis demonstrates that the asymmetric taxation of capital gains and losses fosters investment by eroding the option value of waiting. It also shows that firms controlled by taxable investors employ more equity financing, the higher the firm's stock price and the worse the firm's historical performance. Using a large sample of U.S. industrial firms that are owned by taxable investors between 1970 and 2008, we present new evidence on corporate investment and financing policies, which is supportive of the model's predictions.

Recent empirical studies have shown that innovative firms heavily rely on debt financing. Debt overhang implies that debt hampers innovation by incumbents. A second effect of debt is that it stimulates innovation by entrants. Using a Schumpeterian growth model with endogenous R&D and financing choices, we demonstrate that this second effect always dominates, so that debt fosters innovation and growth at the aggregate level. Our analysis suggests that the relation between debt and investment is more complex than previously acknowledged and highlights potential limitations of empirical work that solely focuses on incumbents when measuring the effects of debt on investment.

We construct firm-level indexes for agency conflicts between controlling shareholders and outside investors by estimating a dynamic model of financing decisions. Our estimates for 12,652 firms from 14 countries show that agency conflicts are large and highly variable across firms and countries. Differences in agency conflicts are largely due to differences in firm-level governance, ownership concentration, and other firm characteristics. The origin of law is more relevant for curtailing governance excesses than for guarding the typical firm. Agency costs split about equally between wealth transfers and value losses from policy distortions. Recent governance reforms in Europe have significantly reduced agency costs.

Most firms face some form of competition in product markets. The degree of competition a firm faces feeds back into its cash flows and affects the values of the securities it issues. Through its effects on stock prices, product market competition affects the prices of options on equity and leads to an inverse relationship between equity returns and volatility, generating a negative volatility skew in option prices. Using a large sample of U.S. equity options, we provide empirical support for this finding and demonstrate the importance of accounting for product market competition when explaining the cross-sectional variation in option skew. Received June 28, 2017; editorial decision October 23, 2018 by Editor Andrew Karolyi. Authors have furnished supplementary Internet Appendices, which is available on the Oxford University Press Web site next to the link to the final published paper online.

How much of a loan should a lender retain, and how do loan sales affect loan performance? We address these questions in a model in which a lender originates loans that it can sell to investors. The lender reduces default risk through screening at origination and monitoring after origination, but is subject to moral hazard. The optimal lender-investor contract can be implemented by requiring the lender to initially retain a share of the loan that it gradually sells to investors, rationalizing loan sales after origination. The model generates novel predictions linking loan and lender characteristics to initial retention, sales dynamics, and loan performance.