Optimal Ownership and Capital Structure with Agency Conflicts

Yunzhi Hu, Zhaojun Yang, and Nanhui Zhu

♦ We develop a continuous-time model examining agency conflicts among controlling shareholders (managers), minority shareholders, and creditors in corporate investment decisions. The manager’s private benefits encourage over-investment, while their equity stake and debt overhang lead to under-investment. We show these offsetting incentive effects can achieve optimal investment timing under certain conditions. Agency costs exhibit U-shaped relationships with private benefits, tax rates, volatility, managerial ownership, and leverage. The model reveals how the interplay among agency conflicts, tax benefits, and bankruptcy costs shapes optimal ownership and capital structure, explaining several documented empirical patterns in corporate finance.

Read it here.