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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.

Suggested Citation

  • Hart, Oliver & Moore, John, 1995. "Debt and Seniority: An Analysis of the Role of Hard Claims in Constraining Management," American Economic Review, American Economic Association, vol. 85(3), pages 567-585, June.
  • Handle: RePEc:aea:aecrev:v:85:y:1995:i:3:p:567-85
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    References listed on IDEAS

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    1. 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.
    2. Berkovitch, Elazar & Kim, E Han, 1990. "Financial Contracting and Leverage Induced Over- and Under-Investment Incentives," Journal of Finance, American Finance Association, vol. 45(3), pages 765-794, July.
    3. Dybvig, Philip H & Zender, Jaime F, 1991. "Capital Structure and Dividend Irrelevance with Asymmetric Information," Review of Financial Studies, Society for Financial Studies, vol. 4(1), pages 201-219.
    4. Leland, Hayne E & Pyle, David H, 1977. "Informational Asymmetries, Financial Structure, and Financial Intermediation," Journal of Finance, American Finance Association, vol. 32(2), pages 371-387, May.
    5. Philippe Aghion & Patrick Bolton, 1992. "An Incomplete Contracts Approach to Financial Contracting," Review of Economic Studies, Oxford University Press, vol. 59(3), pages 473-494.
    6. Harris, Milton & Raviv, Artur, 1991. "The Theory of Capital Structure," Journal of Finance, American Finance Association, vol. 46(1), pages 297-355, March.
    7. Gertner, Robert & Scharfstein, David, 1991. "A Theory of Workouts and the Effects of Reorganization Law," Journal of Finance, American Finance Association, vol. 46(4), pages 1189-1222, September.
    8. Oliver Hart & John Moore, 1998. "Default and Renegotiation: A Dynamic Model of Debt," The Quarterly Journal of Economics, Oxford University Press, vol. 113(1), pages 1-41.
    9. Smith, Clifford Jr. & Warner, Jerold B., 1979. "On financial contracting : An analysis of bond covenants," Journal of Financial Economics, Elsevier, vol. 7(2), pages 117-161, June.
    10. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-275, May.
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    More about this item

    JEL classification:

    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models

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