The objective of the article by Agrawal & Nagarajan (1990) is to study the capital structure of all equity firms where there exists a family relationship among top management as compared to highly levered firms. The paper also discusses the findings on the control of voting rights of both family owned and levered firms.
Based on the study of the capital structure of different firms, the study reports that control over voting rights and family relationship among top management have a significant influence on deciding the capital structure of all-equity firms. The authors point out that, all-equity firms enjoy relatively greater liquidity position. Risks associated with the use of large amounts of personal wealth and involvement of the close relatives in top management positions are found to be the major drivers of capital structure decisions in the all-equity firms examined by the study.
The samples for study were selected using the condition that firms which have not used any long-term debt for a continuous period of five years would be treated as all-equity firms. From the COMPUSTAT Annual Industrial Files, levered firms matching to the size of all-equity firms were selected for comparison. The equity ownership data for two higher level senior executives were collected. A study of the financial and operating characteristics of the selected all-equity firms exhibited the holding of a larger equity by these firms with a fewer shareholders. These firms also had a high leverage with a mean debt/firm value ratio of 40.07%.
The other finding of the study is that all-equity firms show an aversion towards debt. While the all-equity firms had mean ratio of short-term debt to total assets of 2.59%; whereas the mean ratio of levered firms was at 6.54%. Similarly the mean ratio of cash to marketable securities in the case of all-equity firms was found to be at 22.57% much higher than the 6.25% figure for the levered firms. The capital structure and the higher level of liquidity pointed out that the management of all-equity firms had been risk-averse and the results of the study indicate the concern of the managements for increasing the risk by opting for more debt funds.
The next section of the study presents the average equity ownership of all-equity and levered firms. Based on the empirical data collected the study reports that the mean percentage of managerial equity ownership in the case of all-equity firms was higher than that in the case of levered firms. The equity ownership of the senior managers in the case of all-equity firms was 17 and for the levered firms it was 11.
The study also reports on the dollar value of stockholdings of top managers. The mean percentage value of the stock ownership of top managers was reported at 32.00% and 16.00% in the case of all-equity firms and levered firms respectively. According to De Angelo and De Angelo (1985) when there is more than one member of the family is involved in the top management, the firm enjoys greater benefits with respect to managerial vote ownership.
The findings of De Angelo and De Angelo (1985) suggest that firms having dual classes of shareholding with varying voting rights are able to possess substantial managerial control of voting rights and low levels of leverage in the capital structure. In these types of firms the family relationship among the senior managers and board members is found be to be significantly high and the findings also indicate a greater possibility of family involvement in all-equity firms. The data gathered by the study of Agrawal & Nagarajan (1990) find two or more senior managers who are related in respect of 27% of all-equity firms and at least one related manager in respect of more than 50% of all-equity firms. In the case of levered firms the percentage of two or more related managers was found to be 7% and 27% of the firms having at least one related manager.
Jensen and Meckling (1976) are of the view that the managers are averse to the idea of resorting to higher leverage of the firms in view of their fear of corporate bankruptcy and the consequent transfer of control to the bondholders.
However Stulz (1988) has a contradicting view on the aspect of capital structure of the firms. He points out that the chances of a firm to lose greater control over voting rights is more when it issues more of stocks instead of leveraging the firms with debts. This is because there is the likelihood that the dissident shareholders might displace the shareholders. There is also the chance of hostile takeovers. Therefore it can be reasonably be assumed that with a necessity to have a greater managerial risk reduction, there is the need for greater managerial control of voting rights in all-equity firms by involving more family members in management.
The study by Agrawal & Nagarajan (1990) also presents the average equity ownership by directors and officers in all-equity firms by grouping them under three panels – firms in which senior managers are related to each other; firms in which the managers are not related to each other and firms in which managers are neither related to each other nor to the principal shareholders. The liquidity ratio represented by the total value of cash and marketable securities to total assets is another aspect of the study. The study reports that in respect of all-equity firms where several family members occupy senior positions the mean liquidity ratio was found to be 23.72%. The mean percentage liquidity ratio in respect of firms in which senior managers are not related to each other was found to be lower at 16.69% and 16.69% was the ratio for the firms in which none of the family members were involved.
Apart from the family involvement in the management there are other factors which have an influence on the choice of capital structure. Jensen and Meckling have identified the agency costs as one of the factors which influence the capital structure. Myers (1977) states that the agency costs of debt are one of the important factors in the determination of the capital structure of the firms.
The study based on the empirical findings concluded that the managers of all-equity firms have larger stockholdings than those of the similar-sized levered firms and in the case of all-equity firms there is significantly larger family involvement than in the levered firms. The study also concluded that the managerial ownership of all-equity firms has a positive association with the extent of the involvement of family members and the liquidity position in the case of levered firms is lower than that of all-equity firms.