Managerial Stock Ownership and Debt Diversification

• Author: Nemiraja Jadiyappa,Namrata Saikia,Bhavik Parikh
• DOI: http://doi.org/10.1111/irfi.12229
• Published date: 01 September 2020
• Date: 01 September 2020

Managerial Stock Ownership

and Debt Diversification

NEMIRAJA JADIYAPPA

†

,NAMRATA SAIKIA

‡

AND BHAVIK PARIKH

§

†

Department of Finance, Institute of Management Technology, Nagpur, India

‡

Department of Finance and Legal Studies Eberly College of Business and Information

Technology, Indiana University of Pennsylvania, Indiana, PA and

§

Gerald Schwartz School of Business, St Francis Xavier University, Antigonish, Canada

ABSTRACT

In this study, we examine the impact of managerial behavior on the debt

diversification decisions of firms using the agency cost of debt framework.

We hypothesize that managers with higher equity ownership should favor

debt diversification to avoid efficient monitoring by debt holders and thus,

be able to engage in risk-shifting behavior. Our empirical results provide

strong evidence for a positive association between managerial ownership and

debt diversification. This relationship is observed to be stronger for smaller

firms, which are traditionally more susceptible to the moral hazard problem.

Our results remain robust for an alternate measure of debt diversification.

JEL Codes: G21; G30; G32

Accepted: 3 August 2018

Managerial stock ownership in corporate firms has an important role in ensuring

an alignment between managerial goals and shareholders’goals. Prior findings

observe that managers with higher stock ownership tend to use less leverage

(Friend and Lang 1988) or more short-term debt (Datta et al. 2005). Furthermore,

Ang et al. (2000) and Singh and Davidson (2003) show firms with higher mana-

gerial ownership experience less agency costs compared to firms with lower

managerial ownership. These studies are developed around the agency costs of

equity framework where higher stock ownership tends to reduce the extent of

conflict of interests, and associated costs thereof, between the managers and the

shareholders/owners. However, Jensen and Meckling’s (1976) classification of

agency costs into agency costs of equity and agency costs of debt results in differ-

ent implication for managerial behavior. We argue that higher managerial share-

holdings, on one hand decreases the agency costs associated with equity, but on

the other hand increases the agency costs of debt. Managers with greater stock

ownership would be expected to align their interests with that of shareholders

and take decisions that should maximize the equity value of their firms which

could potentially hurt the interests of debtholders. These managers, however,

may not be able to engage in risk-shifting behavior (asset substitution) so as to

maximize shareholder wealth in the presence of intensive monitoring

© 2018 International Review of Finance Ltd. 2018

International Review of Finance, 20:3, 2020: pp. 747–755

DOI: 10.1111/irfi.12229