TY - JOUR AU - Atkeson, Andrew AU - Cole, Harold TI - A Dynamic Theory of Optimal Capital Structure and Executive Compensation JF - National Bureau of Economic Research Working Paper Series VL - No. 11083 PY - 2005 Y2 - January 2005 DO - 10.3386/w11083 UR - http://www.nber.org/papers/w11083 L1 - http://www.nber.org/papers/w11083.pdf N1 - Author contact info: Andrew Atkeson Bunche Hall 9381 Department of Economics UCLA Box 951477 Los Angeles, CA 90095-1477 Tel: 866/312-9770 Fax: 310/825-9528 E-Mail: andy@atkeson.net Harold L. Cole Economics Department University of Pennsylvania 3718 Locust Walk 160 McNeil Building Philadelphia, PA 19104 Tel: 215-898-7788 E-Mail: colehl@sas.upenn.edu AB - We put forward a theory of the optimal capital structure of the firm based on Jensen's (1986) hypothesis that a firm's choice of capital structure is determined by a trade-off between agency costs and monitoring costs. We model this tradeoff dynamically. We assume that early on in the production process, outside investors face an informational friction with respect to withdrawing funds from the firm which dissipates over time. We assume that they also face an agency friction which increases over time with respect to funds left inside the firm. The problem of determining the optimal capital structure of the firm as well as the optimal compensation of the manager is then a problem of choosing payments to outside investors and the manager at each stage of production to balance these two frictions. ER -