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Debt financing and the dynamics of agency costs


Chapter I introduces the research in this dissertation. In Chapter II, I build a model that links the partial liquidation pressed by debt obligations to the asymmetric information about the project quality and the agency costs of the borrower. Facing poor performance, the borrower in the model can sacrifice some future private benefit to generate cash by partial liquidation in order to fulfill his debt obligations. This action taken by the borrower can convince the lender of the long-term solvency of the firm. However, costly liquidations are inefficient, which is pertinent to the costs of business cycles during liquidity crunches. Chapter III conducts a new test of the predictions of agency cost theory, based on the idea that episodes of financial pressure create dynamic incentives for managers to behave efficiently. This study adopts a panel-data vector autoregressions framework, using a large panel of firms, to estimate the dynamic responses of agency costs to financial pressure shocks. The paper shows that these dynamic responses are consistent with the intertemporal substitution effect in managerial agency costs implied by the model in Chapter II. Tests on alternative hypotheses fail to reject the effects of financial pressure. The findings in Chapter III provide strong support to agency theories in the Corporate Finance literature. Chapter IV establishes the limiting distributions of orthogonalized and nonorthogonalized impulse response functions in panel vector autoregressions with a fixed time dimension. The autoregressive parameters are estimated using the GMM estimators and the error variance is estimated using an extended analysis-of- variance type estimator. We find that the GMM estimator of the autoregressive coefficients depends on the estimator of error variance. This asymptotic dependence leads to additional terms in the asymptotic variance of the orthogonalized impulse response functions that are not present in the time series literature. Simulation results show that the asymptotic distribution of the orthogonalized impulse response function that takes the dependence into account is more accurate than the one that does not

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