Agency costs, executive compensation, and firm's choice of payout and financing policies

The interests of a firm's shareholders and other stakeholders frequently diverge. This dissertation consists of three essays on the role of agency problems in corporate financial decision-making.; The first chapter focuses on the conflict of interest between a firm's employees and its shareholders. I show that if employees are compensated with stock options, shareholders may engage in opportunistic share repurchases in order to create stronger incentives for firm's employees. When firm cash flows are uncertain, this generates agency costs due to suboptimal risk sharing. I test model's predictions using 1,295 announcements of open-market repurchases. Consistent with the incentive effect, I find that the market reacts favorably to announcements when the firm has many outstanding and few currently exercisable employee stock options. After repurchases employees receive fewer option grants and decrease their risk exposure by exercising more options.; The second chapter considers whether signaling and free-cash-flow theories explain the market reaction to repurchase announcements. Consistent with signaling, I find that managers are more likely to buy company stock when a firm announces a large repurchase program. The investors use this information, and announcement returns are larger when managers hold more stock. Moreover, high managerial ownership is associated with higher returns only when the announcing firm has a high degree of information asymmetry with the market. Consistent with free cash flow theory, I find that firms with larger cash holdings experience a greater market reaction to repurchase announcements, particularly when they have bad corporate governance.; The third chapter develops a model of optimal capital structure that incorporates the costs of financial distress. First, I consider "customer-driven" financial distress where prices for the firm's output decline whenever asset value is close to the default boundary. I find that the costs of financial distress account for a 6% decrease in optimal leverage and produce higher yield spreads than are predicted by traditional structural models. Second, I explore "employee-driven" financial distress originating from the loss of intangible assets triggered by a decline in firm revenues. Since employee turnover and contract renegotiation impose costs on the firm, shareholders call for lower leverage and higher employee wages.