Specific Human Capital, Credible Commitment and Optimal Capital Structure

1、Specific Human Capital, Credible Commitment and Optimal Capital StructureANNALSOFECONOMICSANDFINANCE5,4759(2004)SpecificHumanCapital,CredibleCommitmentandOptimalCapitalStructureXiaozuWang*SchoolofManagement,FudanUniversity,Shanghai200433,ChinaE-mail:andTianZhuDivisionofSocialScience,H

2、ongKongUniversityofScienceandTechnologyHongKongInthispaper,weshowthatalthoughexanteequityholderswouldliketoadoptanoptimaldisplacementandoperatingpolicy,theymaynothavein-centivestoimplementsuchapolicyexpostwhenthemanageracquiresfirm-specifichumancapitalandbecomesindispensabletothefirmscontinuedop-era

3、tion.Anoptimalmixofdebtandequitycanserveasacommitmentdeviceindiscipliningthemanager.?c2004PekingUniversityPressKeyWords:Capitalstructure;Bankruptcy;Specifichumancapital;Crediblecommitment;Managerialincentive.JELClassificationNumbers:G32,G33.1.INTRODUCTIONEmployeesofafirmoftenacquire(accumulate)firm-

4、specifichumancapi-talduringtheirtenurewiththefirm.Itsimplicationshavebeenextensivelyinvestigatedinlaboreconomics(e.g.,Jovanovic,1979;FelliandHarris,1996),butnotinfinancialeconomics.Inthispaper,westudyanimplica-tionoffirm-specificmanagerialhumancapitalfortheoptimalchoiceofafirmscapitalstructure(i.e.,

5、debt-equityratio).*WewishtothankJustinZhangforhishelpfulcommentsonanearlyversionofthepaper.471529-7373/2002Copyright?c2004byPekingUniversityPressAllrightsofreproductioninanyformreserved.48XIAOZUWANGANDTIANZHUThequestionofoptimalcapitalstructurehaspuzzledeconomistsfordecadessincethetimeofModiglianian

6、dMillersfamousirrelevancethe-orem,whichimpliesthatcapitalstructureisirrelevantintheabsenceoftransactioncosts,taxesandasymmetricinformation.Effortshavebeenmadetorelaxthetheoremsassumptionsinordertoexplainthereal-wordtrade-offsbetweendebt,equityorotherfinancialinstruments(seeHarrisandRaviv(1991)foraco

7、mprehensivesurvey).Onebranchofresearch,followingtheseminalworkbyJensenandMeck-ling(1976),focusesontheagencycostsofcorporatefinance.Agencycostsarisefromconflictsofinterestbetweeninvestorsandmanagersandbetweenshareholdersandcreditors.Theuseofdebtlimitsfirmsfreecashflowsthatmayenablemanagerstoengageine

8、mpirebuildingactivities(Jensen,1986;Stulz,1990),or,bygivingdebtholderstheoptiontoforcebankruptcyintheeventofapoorperformance,imposesapersonalcostonmanagersiftheydonotexertadequateeffortsorenhancesefficienciesinfirmsoperat-ingdecisions(GrossmanandHart,1982;HarrisandRaviv,1990;Chang,1992).Theuseofdebt

9、alsohasitscostssuchasthecostsassociatedwithbankruptcyandexcessiverisk-taking.Optimalcapitalstructureischosentotradeoffthebenefitsandthecostsofdebt.Therearetwoproblemswiththeseagencymodels.First,whyuseacostlymechanismofbankruptcytodisciplinethemanagerwhenequity-holdersinprinciplehavethepowertosimplyf

10、irethemanagerifthefirmperformspoorly?Second,whatpreventsequityholdersfromdoingwhatdebtholderscando?Forexample,whycantequityholdersforcethefirmintobankruptcywhenthefirmsincomeorthedividendpayoutislow?Inthispaper,weshowthatalthoughexanteequityholderswouldliketoadoptanoptimaldisplacementandoperatingpol

11、icy,theymaynothaveincentivestoimplementsuchapolicyexpostwhenthemanageracquiresfirm-specifichumancapitalandbecomesindispensabletothefirmscon-tinuedoperation.However,anoptimalmixofdebtandequitycanserveasacommitmentdeviceindiscipliningthemanager.Morespecifically,weconsideratwoperiodmodel.Inthefirstperi

12、od,themanagerexertsaneffortwhichstochasticallydeterminesthefirst-periodincomeandthe“quality”ofthefirm.Inthesecondperiod,thefirmhasthreeoperatingchoices:itmaycontinueitsbusinessasusual;itcanalsobeliquidated;oritcanreorganize.Thesecond-periodincomedependsonthefirmsqualityandtheoperatingchoice.Ifthefir

13、msqualityisgood,continuationismostefficient;andifthequalityispoor,thefirmshouldbereorganized.Themanagerdislikesdisplacement,liquidationorreorganizationasheenjoysaprivatebenefitfromstayinginpowerandrunningthebusinessasusual.SPECIFICHUMANCAPITAL49Themanageracquiressomefirm-specifichumancapitalinthefir

14、stpe-riodthatisimportanttothefirmscontinuedoperation.1Weassumethatwithoutthemanagerscooperativeparticipation,thefirmcanonlybeliqui-dated.Thus,inthecaseofbadquality,themanager,giventhebargainingpowerderivedfromhisspecifichumancapital,mayinsistoncontinuationandthreatentoquitifhisdemandisrejected.Becau

15、seequityholderspay-offdependsmoreontheuppertailofthefirmsrandomincome,theyprefercontinuationoverliquidation,whichtypicallyyieldsasaferbutlowerre-turn.Whentheyareincontrolofthefirm,theyarelikelytogiveintothemanagersdemandforcontinuationtoavoidliquidation.Thisexplainswhyequityholdersareoftenpassiveini

16、nterveninginmanagement.Ifequi-tyholdersarealwaysincontrolofthefirmsoperation,themanagerwouldbeabletocontinuethebusinessasusualregardlessofhisworkeffort.Thisinturnweakenshisincentivestoworkhardinthefirstperiod.Ontheotherhand,becausedebtholderspayoffreliesmoreonthelowertailofthefirmsincome,theyaremore

17、conservativewithrespecttotakingriskthanequityholdersandhencemaypreferasaferchoiceofliquidationovertheriskiercontinuation.Thus,whenthefirmdefaultsondebtanddebtholderstakecontrol,theymayhaveincentivestoforceliquidationifthemanagerinsistsoncontinuation.Knowingthis,themanagerwouldgiveinandproposereorgan

18、ization,whichistheefficientoutcomeand,forthemanager,betterthanliquidation.Moreover,thepossibilityofliquidationforcedbydebtholdersgivesthemanagerincentivestoworkhardexantetoavoiddefaultandbadquality.Inotherwords,usingdebtcanhelptoimprovebothexanteworkincentivesandexpostoperatingefficiencies.However,t

19、oomuchdebtwouldmakedebtholderspayoffincreasinglyrelyontheuppertailofthefirmsincomeandmovedebtholdersincentivestoliquidateabadqualityfirmclosertothoseofequityholders.ThepaperisrelatedtotheworkbyAghionandBolton(1992),whoarethefirsttoadoptthecontrolrightsapproachtocapitalstructure.Employ-ingtheincomple

20、tecontractframework(Hart,1995),theymodelabilateralfinancingsituationwithonepennilessentrepreneurandawealthyinvestorandstressthecontrolrightsaspectofdebtandequity.Theyprovidecon-ditionsthatgiverisetoeitheranequitycontractorandebtcontract.However,theirmodeldoesnotexplaintheco-existenceofbothdebtandequ

21、ity.DewatripontandTirole(1994)showtheco-existenceofbothdebtandequitybyalsousingtheideathatthedifferenceinequityholdersanddebtholderspayofffunctionsdeterminesthedifferenceintheirincentivestointerveneinmanagement.However,theyonlyconsidertwoexpostoper-1Indeed,Berkovitchetal.(2000)notethatthemarketvalue

22、sofequityanddebtdecreaseifthemanagerisreplacedandthattheexpectedcashflowoffirmsthatretaintheirmanagersexceedsthatoffirmsthatreplacetheirmanagers.50XIAOZUWANGANDTIANZHUatingpossibilities,i.e.,continuationandliquidation,andignorethepossi-bilityofreorganization.Inreality,reorganizationisverycommon.Chap

23、ter11bankruptcyisspecificallyusedtoaccommodatethispossibility.More-over,theydonotexplicitlyconsiderthepossibilitythatthemanagermayacquirefirm-specifichumancapitalthatgiveshimsubstantialbargainingpowerovertheexpostoperatingchoice.Theimplicationoffirm-specificmanagerialhumancapitalfortheopti-maluseofd

24、ebtisalsostudiedbyJaggiaandThakor(1994)andHartandMoore(1994).JaggiaandThakor(1994)identifyacostofdebtfinanceinasituationwherefirm-specifichumancapitaliscostlytoacquire.Inourpaper,specifichumancapitalisacquiredbythemanagerthroughworkatnocost.Theirideaisthefollowing.Along-termwagecontractisneededtopro

25、videincentivesforthemanagertoinvestinfirm-specifichumancap-ital.Highleverageincreasesthepossibilityofbankruptcyandhenceoftheearlyterminationofthecontract.Asthemanagerrationallyanticipatesthecontractualconsequenceofbankruptcy,leverageworsenshisincentivesforhumancapitalinvestment.Thiscostprovidesacoun

26、terbalancetothetaxshieldbenefitofdebtandleadstoanoptimalcapitalstructure.HartandMoore(1994)considerasituationwhereanentrepreneurneedsoutsidefinanceforhisprojectbutcannotcommitnottowithdrawhisspecifichu-mancapitalfromtheproject.Intheirmodel,themanagersspecifichumancapitalisgiven.Thisissimilartoourass

27、umptionofcostlessacquisitionofhumancapital.Buttheirfocusisontheoptimalmaturitystructureofdebt.Therestofthepaperisorganizedasfollows.Section2presentsthemodel.Section3showstheinefficiencyofall-equityfinancinganddis-cussestheroleofdebtinexpostoperatingdecisions.Section4considerstheroleofdebtinimproving

28、exantemanagerialincentivesanddiscussesanempiricalimplicationofthemodel.Section5concludesthepaperbysummarizingtheanalysis.2.THEMODELConsiderafirmthatoperatesfortwoperiods.Inperiod1,themanagerexertsanefforte e,eto,forexample,identifyaproject.Thiseffortstochasticallydeterminesthefirmsquality,denotedasq

29、,whichtakestwovalues:0or1.Ifq=1,wesaytheeffortissuccessful;ifq=0,theeffortisafailure.Letp(e)(0,1)denotetheprobabilitythatanefforteissuccessful.Thus1?p(e)istheprobabilitythattheeffortfails.Weassumep(e)istwicedifferentiableandstrictlyincreasingandstrictlyconcaveine.Attheendoftheperiod,anincomex1isreal

30、izedandisstochasticallydependentonq.SPECIFICHUMANCAPITAL51Inthesecondperiod,thefirmmaycontinueitscurrentoperation,un-dergoamajorreorganization,orsimplybeliquidated.Thesecond-periodincomex2dependsbothonthefirmsqualityqandonwhichofthethreeactions(continuation,reorganizationorliquidation)istaken.Thefir

31、st-periodincomex1and,ifthefirmcontinuesitsoperationasusual,thesecond-periodincomex2aredistributedaccordingtoacumula-tivedistributionfunction,Fc(x|q),over0,x.Thecorrespondingdensityfunctionisfc(x|q).Wefurtherassumethatthemanageracquiressomefirm-specifichumancapitalatnocostinthefirstperiodthatmakeshim

32、indispensabletothefirmscontinuedoperationand,intheabsenceofthemanagerscooperation,thefirmhastobeliquidated.LetFl(x|q)denotethecumulativedistributionfunctionofx2ifthefirmisliquidated.Thecorrespondingdensityfunctionisfl(x|q).Ifthefirmisreorganizedinthesecondperiod,ityieldsanuncertainincomedistributeda

33、ccordingtoacumulativedistributionfunction,Fr(x|q),over0,x.Thecorrespondingdensityfunctionisfr(x|q).Allcumulativedistributionfunctionsareas-sumedtobetwicedifferentiableandallcorrespondingdensityfunctionsbell-shaped.LetV(q),R(q)andL(q)denote,respectively,theexpectedvalueofthesecond-periodincomex2forea

34、chvalueofqifthefirmiscontinued,reor-ganizedandliquidated.Naturally,weassumeV(1)>V(0),R(1)>R(0),andL(1)>L(0).Inaddition,weassumeV(q)>L(q)forq0,1.Inotherwords,continuationalwaysyields,onaverage,ahigherincomethanliquidation.Moreover,wemakethefollowingassumptionabouttheabovecumulativedistrib

35、utionfunctions.Assumption1.Inthesenseoffirst-orderstochasticdominance,Fc(x|1)strictlydominatesFr(x|1)andFl(x|1);andFr(x|0)strictlydominatesFc(x|0)andFl(x|0).Thisassumptionimpliesthatwhentheinitialeffortissuccessful,con-tinuationisamoreefficientoperatingchoicethanbothreorganizationandliquidation;andt

36、hatwhentheinitialeffortisafailure,reorganizationismoreefficientthanbothcontinuationandliquidation.ThemanagersdisutilityfromanefforteisC(e),whereC()istwicedifferentiable,strictlyincreasingandstrictlyconvex.Inaddition,theman-agerenjoyssomeprivatebenefitsWifhestaysinpowerandcontinuestorunthebusinessasu

37、sualinthesecondperiod.Hewillloseasubstantialportionofthebenefitsifareorganizationhastobecarriedoutandallofthebenefitsifheisfiredorthefirmisliquidated.WeuserW,wherer<1,todenotehisprivatebenefitsintheeventofreorganization.52XIAOZUWANGANDTIANZHUAsinanyagencymodel,themanagerasanagentforthefirmsowners

38、needstobemotivatedtobothmakeanadequateeffortexanteandadoptanoptimaloperatingchoiceexpost.Itisassumedasusualthatthemanagerseffortisnotobservable;hencetheincentiveschemecannotbedirectlybasedonit.Inthespiritoftheincompletecontractapproach(Hart,1995),weassumethatthequalityqisnotverifiableandhencecannotb

39、econtractedon.Forsimplicity,weassumethatanincome-basedmanagerialcompen-sationschemeisabsent.Itmaybebecausefirmincomeissubjecttothemanagersmanipulationsothatanincome-basedmonetarycompensationisnotdesirable,oritmaybetoocostlytousesuchameasuretomotivatethemanager(Hart,1995).Weshowhowanappropriately-des

40、ignedcapitalstructurecanactasanincentivedevice.Toavoidthecomplicationoftheissueofsecuritydesign,weconsideronlystandardequity(commonstock)andstandardshort-termdebt.Ashort-termdebtinthismodelisadebtcontractthatentitlesitsholderstoafixedpayment,D,attheendofperiodoneforsomeinitialamountofdebt.Theinitial

41、facevalueofthedebtisirrelevantinthismodel.IfD>x1,thedebtholdersaregrantedcontrolrightsoverthedecisiononthesecond-periodoperation.Otherwise,theequityholders,inprinciple,havethecontrolrights.Attheendofperiodone,thesecurityholdersincontrolhavethefinalsayoverwhetherthefirmshouldcontinueitscurrentoper

42、ation,bereorganizedorbeliquidated.Thevalueoftheequitysharesofthefirmisequaltothemarketvalueofthefirmminusthemarketvalueofthedebt.Weconsiderasimplenoncooperativeextensive-formgamefortheexpostbargainingoverthesecondperiodoperation.Theruleofthegameisasfollows.Attheendofthefirstperiod,themanagerfirstpro

43、posesanoperationofhischoiceand,ifacceptedbythecontrollingsecurityholders,cancarryitoutinthesecondperiod.Iftheproposalisrejected,thefirmisthenliquidated.ThisgameformisconsistentwiththenormalprocedureofChapter11bankruptcy.Thatthemanagercanmakeatake-it-or-leave-itofferreflectshissubstantialbargainingpo

44、wergainedfromhisspecifichumancapital.Allpartiesareassumedtoberisk-neutralandthediscountrateis0.3.THEROLEOFDEBTINEXPOSTOPERATINGDECISIONSLetusshowfirstwhyanall-equitycapitalstructureisineffectiveinbothdiscipliningthemanagerandimplementingexpostefficientoperationdecisions.Ifthefirmhasanall-equityfinan

45、cingmode,theequityholderswouldbebetteroffifthemanagerimplementsamajorreorganizationwhenq=0.SPECIFICHUMANCAPITAL53Themanager,however,wouldliketoproposecontinuation.Sinceliquida-tionyieldsalowerexpectedincomethancontinuation,theequityholderswouldhavetoacceptsuchaproposalandletthemanagercontinuethebusi

46、nessasusual.Knowingthattheequityholderswillbackdown,themanagerhasnoincentivetoproposereorganization.Whenq=1,con-tinuationisgoodbothfortheequityholdersandthemanager.Therefore,regardlessoftheinitialeffort,themanagercanalwaysstayinpowerbyinsistingoncontinuation,andhencehasnoincentivetoexertanyeffortint

47、hefirstperiod.Thisresultissummarizedinthefollowingproposition.Proposition1.Inthecaseofall-equityfinancing,thesecond-periodoperationisalwayscontinuationregardlessoftheoutcomeoftheinitialeffort.Themanagerexertsthelowesteffort,e,inthefirstperiod.Thispropositionimpliesthattheequityholdersarenotabletoexe

48、rciseeffectivelythecontrolrightstheyareentitledto.Theycannotcrediblycommittoliquidatethefirmiftheinitialefforthasfailed.Thequalitativeresultdoesnotdependontheassumptionthatthemanagerhaseffectivelyalltheinterimbargainingpower.Asthemanagercanacquiresomespecifichumancapital,hegainssomebargainingpowerfr

49、omit.Itislikelythattheequityholderswillconcede.Giventhefactthattherearetoolargeanumberofsmallequityholders,itisreasonabletoassumethatcooperativebargainingwithpossiblesidepaymentsisnotpossiblebetweenthetwoparties.Intherestofthesection,weshowhowincorporatingdebtcanincreasetheprobabilityofanefficientex

50、postoperatingdecision.SupposeatthestartofperiodoneanamountofdebtisissuedanditisdueattheendoftheperiodwithafacevalueofD.ThedebtholdersareentitledtoapromisedfixedpaymentDandaregivencontrolrightsupondefault,i.e.,whenx1<D.Upondefault,thedebtholderspayofftocontinuationisVB(D,q,x1)Dfc(x|q)dx+(x1+x)fc(x

51、|q)dxx1+xDx1+x<DD?x1=D?Fc(x|q)dx.(1)0Similarly,thedebtholderspayofftoreorganizationisD?x1RB(D,q,x1)=D?Fr(x|q)dx;(2)054XIAOZUWANGANDTIANZHUandtheirpayofftoliquidationisD?x1LB(D,q,x1)=D?Fl(x|q)dx.(3)0Becauseofthedifferenceinpayoffstructurebetweenequityholdersanddebtholders,theymayhavedifferentprefe

52、renceoverthesecond-periodop-eratingchoices.Specifically,thedebtholderspayoffreliesmoreonthelowerpartoftheincomedistribution;hencetheymaypreferliquidationtocontinuationevenifthelatteryieldshigherexpectedincome.Thisisbe-cause,typically,liquidationissaferthancontinuationafterafailedinitialeffort.Inothe

53、rwords,whilecontinuationhasafatteruppertail,italsohasafatterlowertail.Tosharpentheresult,wefollowDewatripontandTirole(1994)toformalizetheaboveintuitioninthefollowingassumption.Assumption2.Thereexistsanx?>0,suchthatFc(x|0)Fl(x|0)forallxx?andFc(x|0)<Fl(x|0)forallx>x?.BexcauseV(0)>L(0)impli

54、es0Fc(x|0)dx<x0Fl(x|0)dx,bythemean-valuetheorem,thereexistsanx?>x?,suchthatx?Fc(x|0)?Fl(x|0)dx=0.(4)0Assumption2impliesthat,whenthedebtholdershavecontrolrightsaftertheinitialeffortfails,theymayprefertoliquidatethefirmifthemanagerproposescontinuation.Thefollowingpropositionconfirmsthisintuition

55、.Proposition2.Iftheinitialeffortfailsandx1<D<x1+x?,thenthedebtholderstakecontrolandtheoptimaloperatingchoiceisadoptedinperiodtwo.Proof.Ifq=1,continuationwillbeacceptedbyeithertypeofsecurity-holdersbecauseitstrictlydominatestheothertwochoices.Supposeq=0.Thedebtholderstakecontrolupondefault,i.e.

56、,whenD>x1.TheirnetgainsfromliquidationinsteadofcontinuationareD?x1LB(D,0,x1)?VB(D,0,x1)=Fc(x|0)?Fl(x|0)dx.(5)0Therefore,ifD?x1<x?,thenLB(D,0,x1)>VB(D,0,x1),andifD?x1x?,thenLB(D,0,x1)VB(D,0,x1).ThisimpliesthatwhenD<x1+x?,SPECIFICHUMANCAPITAL55thedebtholdersprefertoliquidatethefirmratherth

57、anletthemanagercon-tinue.Knowingthis,themanagershouldproposereorganization.Thiswillbeacceptedbythedebtholdersbecausereorganizationstrictlydominatesliquidation.Proposition2impliesthatdebtcanplayaroleindiscipliningtheman-ager.Lowfirst-periodincomeandbadqualityofthefirmresultingfromaloweffortmayleadtol

58、iquidationifthemanagerproposescontinuation.Becausethemanagerenjoyssomeprivatebenefitsfromreorganization,hewillhavetoproposereorganization.Therefore,theuseofdebtimprovesexpostoperatingdecisions.4.THEROLEOFDEBTINIMPROVINGEXANTEINCENTIVESFromthelastsection,weknowthatifq=1,continuationwillbeac-ceptedbye

59、ithertypeofsecurityholdersbecauseitstrictlydominatestheothertwochoices.Intheabsenceofdefault,continuationwillbeproposedbythemanagerandacceptedbytheequityholdersifq=0.Upondefault,however,themanager,inthecasewhereq=0andx1<D<x1+x?,hastoproposereorganization.Thisisbecausethedebtholderswhowillhavecontrolrightsintheeventofdefaultwillliquidatet