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Debt and Seniority: An Analysis of the Role of Hard Claims in Constraining Management

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  • Hart, Oliver
  • Moore, John

Abstract

The authors argue that long-term debt has a role in controlling management's ability to finance future investments. Companies with high (widely held) debt will find it hard to raise capital, since new security-holders will have low priority relative to existing creditors; conversely for companies with low debt. The authors show that there is an optimal debt-equity ratio and mix of senior and junior debt if management undertakes unprofitable as well as profitable investments. They derive conditions under which equity and a single class of senior long-term debt work as well as more complex contracts for controlling investment behavior. Copyright 1995 by American Economic Association.

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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 85 (1995)
Issue (Month): 3 (June)
Pages: 567-85

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Handle: RePEc:aea:aecrev:v:85:y:1995:i:3:p:567-85

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  1. Oliver Hart & John Moore, 1998. "Default And Renegotiation: A Dynamic Model Of Debt," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 113(1), pages 1-41, February.
  2. Dybvig, Philip H & Zender, Jaime F, 1991. "Capital Structure and Dividend Irrelevance with Asymmetric Information," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 4(1), pages 201-19.
  3. Philippe Aghion & Oliver D. Hart & John Moore, 1994. "The Economics of Bankruptcy Reform," NBER Chapters, in: The Transition in Eastern Europe, Volume 2: Restructuring, pages 215-244 National Bureau of Economic Research, Inc.
  4. Smith, Clifford Jr. & Warner, Jerold B., 1979. "On financial contracting : An analysis of bond covenants," Journal of Financial Economics, Elsevier, Elsevier, vol. 7(2), pages 117-161, June.
  5. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, American Finance Association, vol. 32(2), pages 261-75, May.
  6. Gertner, Robert & Scharfstein, David, 1991. " A Theory of Workouts and the Effects of Reorganization Law," Journal of Finance, American Finance Association, American Finance Association, vol. 46(4), pages 1189-1222, September.
  7. Hayne E. Leland and David H. Pyle., 1976. "Informational Asymmetries, Financial Structure, and Financial Intermediation," Research Program in Finance Working Papers, University of California at Berkeley 41, University of California at Berkeley.
  8. Harris, Milton & Raviv, Artur, 1991. " The Theory of Capital Structure," Journal of Finance, American Finance Association, American Finance Association, vol. 46(1), pages 297-355, March.
  9. Berkovitch, Elazar & Kim, E Han, 1990. " Financial Contracting and Leverage Induced Over- and Under-Investment Incentives," Journal of Finance, American Finance Association, American Finance Association, vol. 45(3), pages 765-94, July.
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