Dynamic investment and capital structure under manager-shareholder conflict

This paper investigates the interactions between the investment and financing decisions of a firm under manager-shareholder conflicts arising from asymmetric information. In particular, we extend the manager-shareholder conflict problem in a real options model by incorporating debt financing. We show that manager-shareholder conflicts over investment policy increase not only the investment and default triggers but also coupon payments, which lead to a decrease in the equity value. Moreover, given the presence of manager-shareholder conflicts, debt financing increases investment and decreases total social welfare. As a result, there is a trade-off between the efficiency of investment and total social welfare with debt financing. These results fit well with the findings of previous empirical work in this area.