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Disputes, Debt and Equity

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  • Duncan, Alfred
  • Nolan, Charles

Abstract

We show how the prospect of disputes over firms revenue reports promotes debt financing over equity. These findings are presented within a costly state verification model with a risk averse entrepreneur. The prospect of disputes encourages incentive regimes which limit penalties and avoid stochastic monitoring, even when the lender can commit to stochastic enforcement strategies. Consequently, optimal contracts shift away from equity and toward standard debt. For a useful special case of the model, closed form solutions are presented for leverage and consumption allocations under efficient debt contracts.

Suggested Citation

  • Duncan, Alfred & Nolan, Charles, 2014. "Disputes, Debt and Equity," SIRE Discussion Papers 2015-29, Scottish Institute for Research in Economics (SIRE).
    • Handle: RePEc:edn:sirdps:617
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    Cited by:

    1. Duncan, Alfred J. M. & Nolan, Charles, 2019. "Disputes, debt and equity," Theoretical Economics, Econometric Society, vol. 14(3), July.
    2. Alfred Duncan & Charles Nolan, 2015. "Objectives and Challenges of Macroprudential Policy," Working Papers 2015_22, Business School - Economics, University of Glasgow.
    3. Le, Vo Phuong Mai & Meenagh, David & Minford, Patrick, 2016. "Monetarism rides again? US monetary policy in a world of Quantitative Easing," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 44(C), pages 85-102.
    4. Alfred Duncan & Charles Nolan, 2017. "Financial Frictions in Macroeconomic Models," Studies in Economics 1719, School of Economics, University of Kent.

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    More about this item

    Keywords

    microeconomics; costly state verification; external finance;
    All these keywords.

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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