: This paper develops a model of financing choice by an entrepreneur about to undertake a project. The entrepreneur is essential for the project but cash-constrained. Thus, he must sell part of the project to outside investors, while remaining in control as a manager. To finance the project he can sell shares to outside equityholders or approach a bank for a loan. The optimal financial structure trades-off an efficient project choice and efficient effort levels. Equity financing does not directly distort the project choice but has a distortionary effect on effort, which in turn may lead to an inefficient choice of project. Bank financing may lead to an inefficient project choice but creates only little effort distrotion for a given project. It is shown that the optimal financial structure varies with project characteristics and the external financing requirement.
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Publisher Info
Paper provided by University of Copenhagen. Department of Economics in its series Discussion Papers with number
99-18.
Length: 27 pages Date of creation: Jul 1999 Date of revision: Handle: RePEc:kud:kuiedp:9918
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