Agency costs in raising capital

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In that same study, there is also evidence that regulation is a substitute for debt maturity in controlling agency costs. These results are consistent with Jiraporn, Kim, Kim and Kitsaburannat (2012). Indeed, this second study shows, using regression with empirical data, that corporate governance quality is linked to leverage. It discusses of agency costs as an explanation of capital structure. The article also investigates on the governance mechanisms determinants on capital structure decisions. Therefore, this study establishes the link between corporate governance and leverage, then we can understand why and how corporate governance can be linked to agency costs. All these factors are linked, and this study can be a key paper to better understand these relations. In this article, we learnt that governance quality is negatively linked to leverage which is interesting to know when you want to raise capital. Then we know that to understand the effect of agency costs on raising capital, we should study and investigate on the corporate governance of companies which affect both leverage and agency costs.

Thanks to all these research papers, we now have a better overview and understanding of the subject and we better know on what to focus for our further research.

Conceptual Framework and Hypothesis Development

Jenson and meckling recognises two types of agency cost. The agency cost of equity, which is the conflict between managers and shareholders, and the agency cost of debt, which is the conflict between shareholders and debt-holders.

In our conceptual Framework and hypothesis development, we will analyse and make hypothesis about two famous theories relative to our research: Pecking order theory, the Trade-off theory of capital structure. But first, we will overview the theory of the firm.

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The Theory of the firm

A. Conceptual framework

First of all, we chose to explain the Theory of the Firm in order to understand the issue of our thesis. In fact, thanks to the results of tests we can have further information for our analysis.

The agency theory, developed by Jensen and Meckling, studies the impact of the managerial ownership structure on the firm performance. This theory can help us to answer to our problem statement because it leads to hypotheses concerning the agency problems. Indeed, according to Jensen and Meckling in 1976, it describes the conflict of interest between self-interested managers, also called the agent, and owners, also called the principal. The main issue is that outside shareholders cannot observe managers’ actions and control if they action are in line with their interest. Thus, the theory suggests that managers do not pursue the best interests of shareholders because managers do not bear the full costs or obtain the full benefits of their decisions. Empirical research had shown the role of agency costs in financing decisions, such as the choice of capital structure. This is the core of our research question.

So, we can wonder if the theory of Jensen and Meckling is a good model to explain the impact of agency problem on firm when raising capital? Is the Theory of the Firm a good tool to understand financing decisions of companies to control agency costs?

B. Empirical implications

The theory stipulates that agency costs would be zero if the owner and the manager of a firm were a sole person. Indeed, it can test hypothesis in order to measure equity and debt agency costs depending on the structure of their ownership and management. Jensen and Meckling argued that debt is an important influence on agency costs. Firms with higher levels of debt are more closely monitored by debt-holders and thus managers have fewer opportunities to pursue non-value maximising activities.

C. Hypothesis development

According to Ang, Cole & Lin (2000), we can find out hypothesis to test:

H1: Agency costs are significantly higher when an outsider rather than an insider manages the firm

H2: Agency costs are inversely related to the manager’s ownership share. Agency costs are higher among firms that are not 100 per cent owned by their managers, and these costs increase as the equity share of the owner-manager declines

H3: Agency costs increase with the number of non-manager shareholders

H4: Agency costs increase are lower with greater monitoring by banks

H5: The impact of managerial decisions on their wealth is proportional to the total wealth they commit to the firm.

II. Pecking order theory

A. Conceptual framework

- Summary

The pecking order theory is one of the most relevant theories of corporate Finance. It assumes that the capital structure is not targeted and that a company would choose to raise capital using the following order: Internal Finance, Debt and finally, Equity. Therefore, a firm would choose retained earnings over debt, short-term debt over long term debt and long term debt over equity. The pecking order theory also argues the existence of information asymmetry between managers and investors. Indeed, insiders (managers) have more information than outsiders (investors) and that they act in favour of shareholders. Finally, the pecking order theory states that a firm should issue the safest security first and that there is an inverse relationship between profitability and debt ratio.

- How theory can be used to analyse the problem

Our objective is to analyse how corporation raise their capital in order to find how they can avoid agency costs when raising capital. Therefore, by analysing the pecking theory, we will be able to see if the theory is relevant nowadays using data from the market. If the theory is relevant, we will be able to forecast the presence (or not) of agency cost by comparing the different companies and analysing the difference that may exist with the theoretical capital structure of companies and their actual capital structure.

B. Empirical implication

One of the empirical implications is that as asymmetric information insiders and outsiders increase, issuing equity is much higher. Indeed, as managers have more information than shareholders,

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