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A Theory of Corporate Financial Structure Based on the Seniority of Claims

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Author Info
Oliver Hart
John Moore

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Abstract

We develop a theory of optinal capital structure based on the idea that debt ath equity differ in their priority status relative to future corporate cash pants. A company with high (dispersed) debt will find it hard to raise new capital since new security-holders will have lew priority relative to existing senior creditors. Conversely for a company with lew debt. We show that there is an optimal debt-equity ratio and mix of senior and junior debt for a corporation whose management may undertake unprofitable as well as profitable investments. Among other things, our theory can explain the obserrvation that profitable firms have low debt. In addition, it predicts that (long-term) debt will be high if new investment is risky ard on average profitable, or if assets in place are risky an new investment is on average unprofitable.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3431.

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Date of creation: Sep 1990
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Publication status: published as (New Title) Debt and Senority: An Analysis of the Role of Hard Claims in Constraining Management. American Economic Review, Vol. 85, no. 3 (June 1995): 567-585.
Handle: RePEc:nbr:nberwo:3431

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  1. Kooyul Jung & Yong-Cheol Kim & Rene M. Stulz, 1994. "Investment Opportunities, Managerial Decisions, and the Security Issue Decision," NBER Working Papers 4907, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. Antti-Jussi Tahvanainen, 2003. "The Capital Structure of Finnish Biotechnology SMEs - An empirical analysisi," Discussion Papers 864, The Research Institute of the Finnish Economy. [Downloadable!]
  3. Larry Lang & Annette Poulsen & Rene M. Stulz, 1994. "Asset Sales, Firm Performance, and the Agency Costs of Managerial Discretion," NBER Working Papers 4654, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  4. Cronqvist, Henrik & Heyman, Fredrik & Nilsson, Mattias & Svaleryd, Helena & Vlachos, Jonas, 2006. "Do Entrenched Manager Pay Their Workers More?," SIFR Research Report Series 47, Swedish Institute for Financial Research. [Downloadable!]
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  5. Michael Brennan & Ian Dunlop, 1991. "Contributing Shares," University of California at Los Angeles, Anderson Graduate School of Management 1171, Anderson Graduate School of Management, UCLA. [Downloadable!]
  6. Heather M. Hulburt & Frederick C. Scherr, 2003. "Determinants of the collateralization of credit by small firms," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 24(6-7), pages 483-501. [Downloadable!]
  7. Lucian Arye Bebchuk & Howard F. Chang, 1991. "Bargaining and the Division of Value in Corporate Reorganization," NBER Technical Working Papers 0097, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Daron Acemoglu, Miles B. Gietzmann, 1998. "Auditor independence, incomplete contracts and the role of legal liability," European Accounting Review, Taylor and Francis Journals, vol. 6(3), pages 355-375, September. [Downloadable!] (restricted)
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