Adeoye, OA (2021) Optimal Capital Structure and Corporate Governance: An Application of Differential Game Theory. PhD thesis, Victoria University.

Abstract

The conflicts of interest between the shareholder and the manager, and the debtholder and the manager create complex dynamical problems. These are central issues of corporate governance as the capital structure of a company impacts the value of the company. The conflicts of interest are also complex dynamical problems because the strategic relationship between the shareholder, debtholder and the manager changes over time and the quality of efforts committed by the manager to maximising the company value are unobservable in each period. To maximise the shareholder, debtholder and company’s value, optimal incentive contracts and mechanism designs of corporate governance are required to motivate the manager to select optimal actions in the company. The implementation of corporate governance in designing an optimal capital structure in corporate finance aims at achieving efficient financial management that can eliminate the agency problems existing among shareholders, managers, and debtholders. The use of debt as a mechanism to resolve agency problems can destabilise the optimal capital structure specification of the company, as suboptimal capital structure introduces the risk of financial distress and bankruptcy. This explains the rising demand for best corporate governance practices. The differential game theory has been proven to be a comprehensive framework in the analysis of non-cooperative games. This study adopts this framework as a dynamic technique to resolve the underlying agency and information asymmetry problems and to establish cooperation and renegotiation proofness over time. The research develops new mathematical models that can embed the static, dynamic principal-agent and information asymmetry issues associated with the choice of an efficient capital structure leading to efficient incentive contracts in a continuous-time setting. The models are solved using Nash open-loop, Nash feedback equilibrium and Pareto optimisation solution concepts to offer robust analysis in a deterministic framework.

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