Academic journal article Journal of Small Business Management

Small Business Borrowing and the Owner-Manager Agency Costs: Evidence on Finnish Data

Academic journal article Journal of Small Business Management

Small Business Borrowing and the Owner-Manager Agency Costs: Evidence on Finnish Data

Article excerpt

This study investigates the impact that managerial ownership has on loan availability and credit terms. We find that managerial ownership is common in a sample of small and medium-sized Finnish firms. Our results suggest that an increase in managerial ownership decreases loan availability. The results on loan interest rates suggest that though an increase in managerial ownership initially increases interest rates, the effect is reversed at higher levels of ownership. Collateral requirements increase monotonically with managerial ownership. Overall, the results suggest that hanks view that there are agency costs involved with managerial ownership even in small and medium-sized firms and that this is taken into account when lending to these firms.

Introduction

Corporate managers often complain about not being able to borrow enough capital at reasonable rates. Berger and Udell (1998) suggest that the constraints in raising external finance are even more pronounced for smaller firms. Storey (1994) further suggests that small firms find it difficult to obtain outside capital, and when they are able to obtain debt capital, it is at high interest rates. Economic theorists suggest that these problems are caused by market frictions, such as information asymmetries and agency costs.

Previous literature suggests that the equity ownership structure of a firm affects the manager-shareholder conflict, and therefore also the agency costs related to these specific information asymmetries. The underlying thought in this literature (Galai and Masulis 1976; Jensen and Meckling 1976) is that when managers' stockholdings increase, management becomes more likely to make decisions consistent with the best interests of other stockholders at the expense of bondholders or other uninformed stakeholders. Consequently, over some level of common stockholdings by managers, larger stockholdings are associated with higher risk of outstanding debt and higher loan return premia. This relationship does not always have to be positive, however. First, as management's stake increases, its wealth becomes less well diversified, so management becomes concerned about the undiversifiable risk of its stake. Second, as management's stake increases, it can use its control of votes to protect its position (Morck, Schleifer, and Vishny 1988; Stub. 1988). As a result of these conflicting forces, both theoretical and empirical evidence, in Morck, Schleifer, and Vishny (1988) and McConnell and Servaes (1990), indicates that managerial ownership tends to affect shareholder wealth positively at low levels of ownership and may affect shareholder wealth negatively at higher levels of ownership.

Even if the relationship between managerial ownership and shareholder wealth has direct implications on the relationship between managerial ownership and bondholder wealth, previous literature on this topic is scarce. The central idea behind these problems is that when companies use debt finance, they have an incentive to take risks that they might avoid when investing the owners' own money. Bagnani, Milonas, and Travlos (1994) suggest that at some level of managerial ownership managers have increased incentives to act in the stockholders' best interests and take risks that are potentially harmful to the bondholders' best interests. Their empirical results are well in line with these arguments, and suggest that managerial ownership increases bond return premia at medium levels of ownership, and lower these premia at higher levels of ownership. These findings suggest that managers who hold medium levels of corporate equity are more willing to take excessive risks than are managers who do not hold equity in the firm or managers who have a very large equity" stake. In practise, this can happen, for example, if the firm invests in projects that are riskier than the ones that it presents to its bank. Or alternatively, the firm can forego positive net present value investments with a low risk because it is not willing to reduce the overall risk level of its investments. …

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