The nonlinear relation between agency costs and managerial equity ownership

Kate Jelinek · Pamela S. Stuerke

49 citations0/0 files storedInternational Journal of Managerial Finance

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Corporate Finance and Governance Auditing, Earnings Management, Governance Family Business Performance and Succession

Abstract

Purpose This paper aims to examine the impact of managerial equity ownership on return on assets as a measure of profitability and two financial statement‐based agency cost measures, i.e. asset utilization and an expense ratio, which proxy for management's efficiency in use of assets and perquisite consumption, respectively. Design/methodology/approach Multivariate tests are constructed to examine the nonlinear relation between managerial equity ownership and both profitability and agency costs, using interaction terms to capture the relation at various levels of managerial ownership. Findings The paper documents that managerial equity ownership is nonlinearly and positively associated with return on assets and asset utilization, and nonlinearly and negatively associated with the expense ratio, after controlling for firm size, leverage, corporate diversification, institutional ownership, research intensity, firm age, and executive stock options. Research limitations/implications The results imply that the ability of managerial equity ownership to reduce agency costs decreases as levels of ownership increase. Further, the results indicate that, in some industries, high levels of ownership lead to increased expense ratios, suggesting increased perquisite consumption. Finally, these results suggest that, above a certain level in some industries, managerial equity ownership only marginally encourages efficient asset utilization but does not significantly deter excessive spending. Originality/value The paper provides a link between research that demonstrates a linear relation between managerial equity ownership and financial‐statement based profitability and agency cost measures and research that finds a nonlinear relation between managerial equity ownership and Tobin's Q, a proxy for firm performance.

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References

1976Theory of the firm: Managerial behavior, agency costs and ownership structure 1983Separation of Ownership and Control 1986Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers 1996Agency costs of free cash flow, corporate finance, and takeovers 1993The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems 1988Management ownership and market valuation 1985The Structure of Corporate Ownership: Causes and Consequences 1997Industry costs of equity

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