An Empirical Test of the Impact of Managerial Self-Interest on Corporate Capital Structure

IRWIN FRIEND and LARRY H. P. LANG *
ABSTRACT
This paper provides a test of whether capital structure decisions are at least in part
motivated by managerial self-interest. It is shown that the debt ratio is negatively
related to management's shareholding, reflecting the greater nondiversifiable risk of
debt to management than to public investors for maintaining a low debt ratio. Unless
there is a nonmanagerial principal stockholder, no substantial increase of debt can be
realized, which may suggest that the existence of large nonmanagerial stockholders
might make the interests of managers and public investors coincide.
A RECENT PAPER BY Friend and Hasbrouck (F-H) [7] used data on holdings of
stock owned by managerial insiders (officers and directors) to test the hypothesis
that the corporate capital structure is determined at least in part by optimization
of management interests even when these interests conflict with stockholders'
interests. The value of the stock held by corporate insiders (MV) and the ratio
of their holdings to the total value of their stock outstanding (FR) were used in
that study as measures of the greater incentive to management than to other
stockholders for maintaining a low debt ratio to avoid bankruptcy possibility.
The regression results were supportive of the hypothesized inverse relationship
between unscaled MV and debt, but a less satisfactory result was obtained when
MV was scaled by logarithm or FR was used as a second measure of the relevant
risk. The result less satisfactory than expected seems to question the ability of
management in adjusting debt ratio by its own interests, especially when these
conflict with stockholdprs' interests.