1、1 Capital Structure and Firm Performance 1. Introduction Agency costs represent important problems in corporate governance in both financial and nonfinancialindustries. The separation of ownership and control in a professionally managed firm may result in managersexerting insufficient work effort, i
2、ndulging in perquisites, choosing inputs or outputs that suit their ownpreferences, or otherwise failing to maximize firm value. In effect, the agency costs of outside ownership equalthe lost value from professional managers maximizing their own utility, rather than the value of the firm. Theory sug
3、gests that the choice of capital structure may help mitigate these agency costs. Under theagency costs hypothesis, high leverage or a low equity/asset ratio reduces the agency costs of outside equity andincreases firm value by constraining or encouraging managers to act more in the interests of shar
4、eholders. Sincethe seminal paper by Jensen and Meckling (1976), a vast literature on such agency-theoretic explanations ofcapital structure has developed (see Harris and Raviv 1991 and Myers 2001 for reviews). Greater financialleverage may affect managers and reduce agency costs through the threat o
5、f liquidation, which causes personallosses to managers of salaries, reputation, perquisites, etc. (e.g., Grossman and Hart 1982, Williams 1987), andthrough pressure to generate cash flow to pay interest expenses (e.g., Jensen 1986). Higher leverage canmitigate conflicts between shareholders and mana
6、gers concerning the choice of investment (e.g., Myers 1977), the amount of risk to undertake (e.g., Jensen and Meckling 1976, Williams 1987), the conditions under which thefirm is liquidated (e.g., Harris and Raviv 1990), and dividend policy (e.g., Stulz 1990). A testable prediction of this class of
7、 models is that increasing the leverage ratio should result in loweragency costs of outside equity and improved firm performance, all else held equal. However, when leveragebecomes relatively high, further increases generate significant agency costs of outside debt including higherexpected costs of
8、bankruptcy or financial distress arising from conflicts between bondholders andshareholders.1 Because it is difficult to distinguish empirically between the two sources of agency costs, wefollow the literature and allow the relationship between total agency costs and leverage to be nonmonotonic. Des
9、pite the importance of this theory, there is at best mixed empirical evidence in the extant literature(see Harris and Raviv 1991, Titman 2000, and Myers 2001 for reviews). Tests of the agency costs hypothesistypically regress measures of firm performance on the equity capital ratio or other indicato
10、r of leverage plussome control variables. At least three problems appear in the prior studies that we address in our application.In the case of the banking industry studied here, there are also regulatory 2 costs associated with very high leverage. First, the measures of firm performance are usually
11、 ratios fashioned from financial statements or stockmarket prices, such as industry-adjusted operating margins or stock market returns. These measures do not netout the effects of differences in exogenous market factors that affect firm value, but are beyond managementscontrol and therefore cannot r
12、eflect agency costs. Thus, the tests may be confounded by factors that areunrelated to agency costs. As well, these studies generally do not set a separate benchmark for each firmsperformance that would be realized if agency costs were minimized. We address the measurement problem by using profit ef
13、ficiency as our indicator of firm performance.The link between productive efficiency and agency costs was first suggested by Stigler (1976), and profitefficiency represents a refinement of the efficiency concept developed since that time.2 Profit efficiencyevaluates how close a firm is to earning th
14、e profit that a best-practice firm would earn facing the sameexogenous conditions. This has the benefit of controlling for factors outside the control of management that arenot part of agency costs. In contrast, comparisons of standard financial ratios, stock market returns, and similarmeasures typi
15、cally do not control for these exogenous factors. Even when the measures used in the literature areindustry adjusted, they may not account for important differences across firms within an industry such as localmarket conditions as we are able to do with profit efficiency. In addition, the performanc
16、e of a best-practicefirm under the same exogenous conditions is a reasonable benchmark for how the firm would be expected toperform if agency costs were minimized. Second, the prior research generally does not take into account the possibility of reverse causation fromperformance to capital structur
17、e. If firm performance affects the choice of capital structure, then failure to takethis reverse causality into account may result in simultaneous-equations bias. That is, regressions of firmperformance on a measure of leverage may confound the effects of capital structure on performance with theeff
18、ects of performance on capital structure. We address this problem by allowing for reverse causality from performance to capital structure. Wediscuss below two hypotheses for why firm performance may affect the choice of capital structure, theefficiency-risk hypothesis and the franchise-value hypothe
19、sis. We construct a two-equation structural model andestimate it using two-stage least squares (2SLS). An equation specifying profit efficiency as a function of the2 Stiglers argument was part of a broader exchange over whether productive efficiency (or X-efficiency) primarily reflectsdifficulties i
20、n reconciling the preferences of multiple optimizing agents what is today called agency costs versus “true” inefficiency, or failure to optimize (e.g., Stigler 1976, Leibenstein 1978). firms equity capital ratio and other variables is used to test the agency costs hypothesis, and an equationspecifyi
21、ng the equity capital ratio as a function of the firms profit 3 efficiency and other variables is used to testthe net effects of the efficiency-risk and franchise-value hypotheses. Both equations are econometricallyidentified through exclusion restrictions that are consistent with the theories. Thir
22、d, some, but not all of the prior studies did not take ownership structure into account. Undervirtually any theory of agency costs, ownership structure is important, since it is the separation of ownership andcontrol that creates agency costs (e.g., Barnea, Haugen, and Senbet 1985). Greater insider
23、shares may reduceagency costs, although the effect may be reversed at very high levels of insider holdings (e.g., Morck, Shleifer, and Vishny 1988). As well, outside block ownership or institutional holdings tend to mitigate agency costs bycreating a relatively efficient monitor of the managers (e.g
24、., Shleifer and Vishny 1986). Exclusion of theownership variables may bias the test results because the ownership variables may be correlated with thedependent variable in the agency cost equation (performance) and with the key exogenous variable (leverage)through the reverse causality hypotheses no
25、ted above To address this third problem, we include ownership structure variables in the agency cost equationexplaining profit efficiency. We include insider ownership, outside block holdings, and institutional holdings. Our application to data from the banking industry is advantageous because of th
26、e abundance of qualitydata available on firms in this industry. In particular, we have detailed financial data for a large number of firmsproducing comparable products with similar technologies, and information on market prices and otherexogenous conditions in the local markets in which they operate
27、. In addition, some studies in this literature findevidence of the link between the efficiency of firms and variables that are recognized to affect agency costs,including leverage and ownership structure (see Berger and Mester 1997 for a review). Although banking is a regulated industry, banks are s
28、ubject to the same type of agency costs and otherinfluences on behavior as other industries. The banks in the sample are subject to essentially equal regulatoryconstraints, and we focus on differences across banks, not between banks and other firms. Most banks are wellabove the regulatory capital mi
29、nimums, and our results are based primarily on differences at the mar 2. Theories of reverse causality from performance to capital structure As noted, prior research on agency costs generally does not take into account the possibility of reversecausation from performance to capital structure, which may result in simultaneous-equations bias. We offer twohypotheses of reverse causation based on violations of the Modigliani-Miller
