Leverage, managerial monitoring and firm valuation: A simultaneous equation approach

The paper examines how leverage and managerial ownership relate to firm valuation. It is argued that both leverage (which serves as an external monitoring function) and managerial ownership (which serves as an internal monitoring function) affect firm value, while internal monitoring by managers and external monitoring through debt were viewed as substitutes or complements. After controlling for the effect of exogenous variables, the results reveal the existence of a substitution monitoring effect between debt and the managerial group. Additionally, firm valuation is found to exert a significant influence on managerial ownership and vice versa. Robustness tests indicate a weak but growing role of bank debt as a disciplinary mechanism. (C) 2007 University of Venice. Published by Elsevier Ltd. All rights reserved.