AGENCY* COSTS AND OWNERSHIP STRUCTURE: EVIDENCE FROM THE SMALL BUSINESS FINANCE SURVEY DATA BASE

In this paper, “agency” refers to the relationship between a principal, such as a business owner or owners, and his or her agent, such as a manager.Our empirical results support the John-Kedia theory, which recommends treating optimal corporate governance as a system within which the internal control variables, such as manager-owners, family-owners, and major and minor shareholders, interact with the external agents such as banks and bondholders and act to minimize or eliminate agency problems. We argue in this study that if the internal variables provide similar functions, they could substitute for each other. Similar argument holds for external control variables. Since external stakeholders such as banks and bondholders have different claims than owners and shareholders, we hypothesize that external and internal monitoring mechanisms provided by these groups will be a complement; they will reinforce each other. Using the OLS method and SUR, we find that the interaction effect and substitute-complement relationship are supported by the sales-to-asset data. Specifically, family ownership seems to replace bondholders in monitoring managerial behavior. We find that good managers do not attempt to differentiate themselves from the bad ones by pre-commitment. The pre-committed-based governance system proposed by John and Kedia (2003) is therefore not supported by the small firm samples.