Corporate Governance and Capital Structure Dynamics





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    • Erwan Morellec is with Ecole Polytechnique Fédérale de Lausanne (EPFL), Swiss Finance Institute, and CEPR. Boris Nikolov is with the William E. Simon Graduate School of Business Administration, University of Rochester. Norman Schürhoff is with the Faculty of Business and Economics at University of Lausanne, Swiss Finance Institute, and CEPR. We thank an anonymous referee, the Associate Editor, the Editor (Campbell Harvey), and Darrell Duffie for many valuable comments and Julien Hugonnier for suggesting an elegant approach to the calculation of conditional densities in our setting. We also thank Tony Berrada, Peter Bossaerts, Bernard Dumas, Michael Lemmon, Marco Pagano, Michael Roberts, René Stulz, Toni Whited (AFA discussant), Marc Yor, Jeff Zwiebel, and seminar participants at Boston College, Carnegie Mellon University, HEC Paris, the London School of Economics, the University of Colorado at Boulder, the University of Lausanne, the University of Pennsylvania, the University of Rochester, the 2008 American Finance Association meetings, 2008 North American Summer Meetings of the Econometric Society, and the conference on “Understanding Corporate Governance” organized by the Fundación Ramón Aceres in Madrid for helpful comments. Erwan Morellec and Norman Schürhoff acknowledge financial support from the Swiss Finance Institute and from NCCR FINRISK of the Swiss National Science Foundation.


We develop a dynamic tradeoff model to examine the importance of manager–shareholder conflicts in capital structure choice. In the model, firms face taxation, refinancing costs, and liquidation costs. Managers own a fraction of the firms’ equity, capture part of the free cash flow to equity as private benefits, and have control over financing decisions. Using data on leverage choices and the model's predictions for different statistical moments of leverage, we find that agency costs of 1.5% of equity value on average are sufficient to resolve the low-leverage puzzle and to explain the dynamics of leverage ratios. Our estimates also reveal that agency costs vary significantly across firms and correlate with commonly used proxies for corporate governance.