Academic journal article Journal of Small Business Management

Do Banks Price Owner-Manager Agency Costs? an Examination of Small Business Borrowing *

Academic journal article Journal of Small Business Management

Do Banks Price Owner-Manager Agency Costs? an Examination of Small Business Borrowing *

Article excerpt

Ang, Cole, and Lin (2000) provide evidence that supports the theoretical work of Jensen and Meckling (1976) on agency costs. As a further examination, I conduct a test to determine the economic significance of owner--manager agency conflicts. Using the same data source and empirical framework as Ang, Cole, and Lin (2000), I test to determine if banks charge a premium when extending loans to firms with various ownership structures. In empirical tests, I find that banks do not require an owner-manager agency premium either through increased interest rates or through the requirement of collateral. Instead, I find that the interest rate is significantly affected by the length of the longest banking relationship, the number of banking relationships, firm age, and firm size. Additionally the requirement of collateral is significantly affected by the number of banking relationships, the debt position of the firm, and firm size.


In a recent article, Ang, Cole, and Lin (2000) (hereafter ACL) find empirical evidence of the owner--manager agency costs theorized by Jensen and Meckling (1976). (1) ACL use two proxies for owner--manager agency costs: the expense ratio (that is, operating expenses/sales) and the total asset turnover ratio (that is, sales/assets). These two ratios measure how efficient the manager operates and are intended to proxy for the owner--manager agency costs suffered by the firm. Using a sample drawn from the Federal Reserve Board's National Survey of Small Business Finances (NSSBF), the authors compare the base Jensen and Meckling (1976) zero agency cost firm (that is, a firm with a single owner--manager) to firms with different ownership structures.

ACL find that agency costs (as measured by the expense and turnover ratios) are significantly higher when an outsider manages the firm and are significantly lower with greater monitoring by banks. Additionally, they report that agency costs are related inversely to the manager's ownership share and are related directly to the number of nonmanager shareholders. The authors conclude that the ownership structure of a firm significantly impacts the degree of agency costs.

In this paper, I extend the work of ACL by testing to determine if banks price owner-manager agency costs within borrowing firms. The bank pricing issue is important because it allows for the measurement of the impact of owner-manager agency costs on firm value. Ideally, a researcher would like to test the impact of the various ownership structures (that is, the owner-manager agency costs) on firm stock prices to determine if the costs are priced. Unfortunately the firms included in the NSSBF survey generally are not publicly traded, and the survey neither identifies nor provides market price data for those that are publicly traded. Without the stock market data, ACL cannot relate agency costs to firm value but rather can only show that agency costs as measured by the two performance ratios are related to ownership structure and to the degree of monitoring. This paper differs from ACL in that I construct an alternate methodology to determine if the owner-manager agency costs impact firm value.

If owner-manager agency costs decrease firm value and therefore increase the probability of loan default, banks should price these costs in one of two ways: Banks should increase the interest rate (referred to as the interest rate agency premium); and/or banks should require collateral (referred to as the collateral agency premium). (2)

If the interest rate and collateral premiums exist, then one can infer that owner-management agency conflicts impact firm value. Banks specialize in gathering data and making loans, so they can be thought of as highly informed investors. Showing that these informed investors not only detect potential agency problems but also deem them important enough to price would provide evidence that agency costs are both statistically and economically significant. …

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