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Property Rights, Risk and Leverage

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Author Info

  • Graff, Richard A.

    (Electrum Partners L.L.C.)

  • Kairys, Jr. Joseph P.

    ()
    (Department of Economics, School of Economics and Commercial Law, Göteborg University)

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    Abstract

    Risk matters when corporate debt has a positive probability of default. Lenders have traditionally used covenants to protect their property rights because the financing and operating decisions of firms can reduce the value of the firm’s outstanding debt. We examine the use of captive finance subsidiaries and special purposed entities (SPEs) to partition default risk within the firm. A more complex arrangement of property rights within the firm allows the parent firm to retain operating flexibility while offering lenders better protection. We conclude that capital structure is a relevant decision variable for corporate managers because firms are able to obtain leveraged finance at a lower cost when risk is partitioned using separate legal structures within the firm.

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    File URL: http://hdl.handle.net/2077/2711
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    Bibliographic Info

    Paper provided by University of Gothenburg, Department of Economics in its series Working Papers in Economics with number 183.

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    Length: 44 pages
    Date of creation: 31 Oct 2005
    Date of revision:
    Handle: RePEc:hhs:gunwpe:0183

    Contact details of provider:
    Postal: Department of Economics, School of Business, Economics and Law, University of Gothenburg, Box 640, SE 405 30 GÖTEBORG, Sweden
    Phone: 031-773 10 00
    Web page: http://www.handels.gu.se/econ/
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    Keywords: capital structure; captive finance companies; structured finance;

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    References

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