Do Decision Makers' Debt-risk Attitudes Affect the Agency Costs of Debt?

Current Agriculture, Food & Resource Issues

G. Hailu, E. W. Goddard and S. R. Jeffrey

payments attributable to members in good economic conditions, the same debt will also
increase bankruptcy risks or agency costs (Berens and Cuny, 1995). Co-operatives with
relatively high debt-to-equity ratios may exhibit more variability in terms of returns.
Moreover, higher aggregate co-operative sector-level leverage may be associated with co-
operative business instability. According to Robison and Barry (1987), optimal debt for a
business depends on, among other things, the DM’s risk attitude. For example, a risk
averse DM would tend to hold less debt (MacCrimmon and Weherug, 1986), ceteris
paribus. Moreover, as opposed to managers, directors/members are likely to tolerate
higher debt-to-equity ratios in the firm’s capital structure since they hold diversified
portfolios (Firth, 1995). On the other hand, based on the takeover hypothesis, managers
who believe they are under a threat of takeover (Stultz, 1988) may desire higher levels of
debt as the presence of high leverage may repel the potential bidders through the threat of
coinsurance (Billett, 1996; Safieddine and Titman, 1999). Thus, in developing risk-based
ranges of optimal debt policies, the extent to which managers or boards of directors
(BODs) exhibit risk taking or risk averse behaviour when making decisions with a variety
of financial data is of specific interest.

Issues around risk attitudes may also be linked to firm performance. Since the
objective of a co-operative business is the maximization of its members’ welfare
(Bateman, Edwards and LeVay 1979; Enke, 1945), efficient allocation of the co-
operative’s resources will be critical in determining whether the co-operative is
competitive nationally and/or internationally. Theoretical evidence suggests that co-
operative businesses are less efficient than investor-owned firms (Sexton, Wilson and
Wann, 1989), possibly due to a lack of business expertise on the part of directors as
compared to directors of investor-owned firms (Helmberger, 1966) and the lack of an
incentive structure in co-operatives to induce management to run the association
efficiently (Caves and Petersen, 1986). These problems may be related to risk attitude
differentials between managers and directors, leading to differing opinions regarding
investment, consolidation and borrowing and ultimately firm financial risk exposure and
implemented risk management strategies.

Agency theory suggests that conflicts between owners and managers can arise
because of differences in their attitudes toward risk (Eisenhardt, 1989). Because of
different risk preferences, managers and directors may prefer different actions. Thus, risk
attitude incompatibility may impede overall efficiency of resource use. In terms of
Canadian co-operative businesses, relatively little is known about the risk attitudes of co-
operative business DMs. Moreover, previous studies have not attempted to scrutinize
empirically the impact of risk attitude differentials on co-operative capital structure
decision processes and, ultimately, on firm value. This study examines the degree to
which differences in risk attitudes exist between co-operative managers and directors. The
impact managers’ and directors’ attitudes toward debt have on their intention to take on
additional debt is also examined.

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