Agency Conflicts Around the World

Erwan Morellec is Professor of Finance at the  University Lausanne and the Swiss Finance Institute; Boris Nikolov is Assistant Professor of Finance at the University of Lausanne and the Swiss Finance Institute; and Norman Schürhoff is Professor of Finance at the University of Lausanne and the Swiss Finance Institute. This post is based on their recent article, forthcoming in the Review of Financial Studies. Related research from the Program on Corporate Governance includes The Elusive Quest for Global Governance Standards by Lucian Bebchuk and Assaf Hamdani.

We offer a novel approach to measuring agency conflicts. Instead of counting governance provisions that are endogenous to the prevalence of agency conflicts and the institutional and legal environment, we construct theory-grounded indexes of agency conflicts based on revealed managerial preferences. For this purpose, we develop and estimate a dynamic capital structure model augmented by agency. We focus on two types of agency conflicts: controlling-minority shareholders conflicts and shareholder-bondholder conflicts. The indexes are available at the firm level across 14 countries.


Empirical researchers have developed a number of indexes for corporate governance and investor protection. These indexes count the number of governance provisions addressing the expropriation of outside investors. Governance provisions, however, do not measure the extent of agency frictions or the distortions caused by them. Instead, they capture the response of the institutional and legal environment to their prevalence.

In our article, we follow a radically different approach and infer agency conflicts from the distortions they cause in corporate policy choices. We construct our theory-grounded indexes of agency conflicts at the firm by backing out the incentive problems within the firm from the consequences they have on observed policy choices in the data, rather than by counting governance provisions. Complementing the prior literature that focuses on corporate governance mechanisms (the cure), we quantify the severity of the underlying agency frictions (the disease). We do so by developing a dynamic model of financing choices with agency conflicts and using data on observable variables—the level, variability, persistence, and other (un)conditional moments of firms’ financial leverage—to infer properties of unobserved variables—agency conflicts. Our structural estimation uses novel data on international ownership structures and a simulated maximum likelihood (SML) method that captures cross-sectional firm heterogeneity, rather than assuming a representative firm.

The structural estimation approach requires a tractable, yet credible, model to benchmark actual corporate behavior to the model-implied first-best and second-best behaviors under varying degrees of agency conflicts. A large theoretical literature has shown that conflicts of interest can cause distortions in financial policies. For this reason, we augment a workhorse dynamic capital structure model with agency conflicts. In our model, financing choices reflect two types of conflicts of interest among stakeholders, on top of the standard trade-off between the tax advantage of debt, the costs of issuing securities, and default costs. First, controlling shareholders can pursue private benefits at the expense of minority shareholders. Second, shareholders can extract concessions from creditors by renegotiating debt contracts in default.


Our empirical analysis delivers several novel results. First, we find that moderate agency conflicts are sufficient to explain firms’ financing behavior across a variety of institutional and legal settings. Agency theory has thus the potential to resolve several stylized capital structure puzzles. Our estimates for private control benefits represent 2.6% (4.4%) of free cash flows for the median (average) firm, and shareholder advantage in default represents 45% (42%) of the renegotiation surplus. Median private benefits of control are lower than the mean, suggesting that they are of moderate importance for the typical firm but large for some firms in all countries. Shareholders’ renegotiation power is distributed more symmetrically, but much larger than stipulated by the absolute priority rule. Shareholders can extract substantial concessions from creditors when firms approach financial distress.

Second, agency conflicts systematically vary across firms both between and within countries. The variation across countries in agency conflicts is small for the average firm, but it is large in the tails. A maximum of 2% of the variation in control benefits across firms and 1% in shareholders’ renegotiation power in default can be attributed to the country of origin. The effect of legal provisions is very pronounced in the right tail. Notably, the legal environment seems less effective in civil law countries at curtailing governance excesses that in common law countries, as evidenced by the larger fraction of firms with large amounts of resources diverted. The origin of law and other country determinants are thus more relevant for curtailing governance excesses than for guarding the typical firm, consistent with costly enforcement.

Differences in agency conflicts are largely due to differences in firm-level governance, ownership concentration, and other firm characteristics. Agency costs relate to firm characteristics in the same way in all countries. Firms with more cash, higher market-to-book ratio, and more intangible assets are those with the largest agency costs. Ownership concentration by family and other individuals is, consistent with agency theory, one of the single most important determinants of control benefits. Overall, firm-specific factors explain variation in agency conflicts better than country factors.

The value losses from agency conflicts are large. The total loss to minority shareholders has two parts, a part due to rent extraction and another due to financial distortions. While rents are a transfer from one class of shareholders (minority) to another (controlling), financial distortions destroy overall value. We find agency conflicts reduce firm value by 5.4% on average, with about equal shares coming from net transfers between stakeholders (57%) and net losses due to financial distortions (43%). The composition of agency costs varies strongly across countries. In countries where incentives are less aligned due to more dispersed ownership, such as the United States, financial distortions constitute a larger portion (63%) of agency costs, with wealth transfers (37%) making up the remainder. Counterfactual policy experiments show that agency costs mostly arise from control benefits and the financial frictions that they cause. That is, improving corporate governance to diminish private benefits of control has a larger effect than strengthening creditor rights alone.

Comparing agency frictions before and after regulatory reforms shows that the corporate governance and bankruptcy code reforms of the 2000s in France and Italy had a strong impact on the control advantage and the shareholder advantage in default. In line with the stated intent of “greater voice” to minority shareholders, we find a significant reduction in the private benefits of the controlling shareholders. Similarly, in line with the stated intent of facilitating debt renegotiations while protecting debtors, we find a significant increase in shareholders’ bargaining power in default.

The complete article is available here.

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