Managerial Conservatism, Project Choice, and Debt
- 1 July 1992
- journal article
- Published by Oxford University Press (OUP) in The Review of Financial Studies
- Vol. 5 (3) , 437-470
- https://doi.org/10.1093/rfs/5.3.437
Abstract
We show that the incentive for managers to build their reputations distorts firms' investment policies in favor of relatively safe projects, thereby aligning managers' interests with those of bondholders, even though managers are hired and fired by shareholders. Tbis effect opposes the familiar agency problem of risky debt that is imperfectly covenant-protected, wherein shareholders are tempted to favor excessively risk projects in order to expropriate bondholders. Consequently, when managerial concern for reputation results in conservatism, it can actually make shareholders better off ex ante by allowing the firm to issue more debt. We examine how the optimal choice of leverage from the shareholders' standpoint is influenced by takeover activity, and how the adoption of antitakeover measures affects a firm's investment policy and leverage choice.Keywords
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