1-3 - Capital Structure in Asia and CEO Entrenchment Kin...

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Capital Structure in Asia and CEO Entrenchment Kin Wai Lee* S3-B2A-19 Nanyang Business School Nanyang Technological University Nanyang Avenue Singapore 639798 Tel : (65) 6790 4663 Fax : (65) 6795 1587 E-mail: akwlee@ntu.edu.sg Gillian Hian Heng Yeo S3-1A-21 Nanyang Business School Nanyang Technological University Nanyang Avenue Singapore 639798 Tel : (65) 6790 5622 Fax : (65) 6795 1587 E-mail: Ahhyeo@ntu.edu.sg *contact author 1 November 2007 1
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Abstract We examine the association between CEO entrenchment and capital structure decisions of Asian firms. We find that firms with higher CEO entrenchment have lower level of leverage. Specifically, firms with CEO who chairs the board, lower proportion of outside directors and higher CEO tenure, have lower leverage. The negative association between CEO entrenchment and corporate leverage is more pronounced in firms with higher agency costs of free cash flow. In addition, for firms with entrenched CEOs, those with greater institutional investors’ equity ownership have higher leverage. This result suggests that active monitoring by large shareholders mitigate entrenched CEOs’ incentives to avoid debt. 2
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A considerable body of research has focused on managers deviating from optimal level of capital structure due to conflict of interest between managers and shareholders. One stream of research suggests that leverage reduces managerial discretion over corporate resources because higher debt financing increases the commitment and pressure to distribute surplus cash as repayment of debt obligations (Jensen 1986). Thus, entrenched managers prefer capital structures with low leverage. Another stream of research suggests that entrenched managers have greater incentives to increase leverage beyond the optimal level to reduce the probability of successful takeovers by increasing the concentration of their shareholdings, which enables them to have greater control of in their firms (Harris and Raviv (1988) and Stulz (1988)). Prior studies on US listed firms provide some evidence that entrenched managers prefer low corporate leverage. Friend and Lang (1988) and Mehran (1992) find that firms with high agency costs of managerial discretion have low leverage levels. Using a sample of large US industrial firms, Berger, Ofek and Yermack (1997) find that leverage levels are lower when CEOs do not face pressure from ownership and compensation incentives or active monitoring. They also document that leverage increases significantly in the aftermath of events that represent entrenchment-reducing shocks to managerial security such as unsuccessful tender offers, involuntary CEO replacements, and the addition to the board of major shareholders. However, given the opposing theories on the association between the capital structure decisions and managerial entrenchment, the empirical evidence supporting these views are hard to generalize, especially in other economies. 3
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1-3 - Capital Structure in Asia and CEO Entrenchment Kin...

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