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Debt, hedging and human capital

  • Smith, Stephen D.
  • Wall, Larry D.

This paper provides a theory of debt and hedging based on human capital. We distinguish human capital from physical capital in two ways: (1) human capital is inalienable and can exercise a one-sided option to leave the firm and (2) human capital is not perfectly replaceable. We show that a firm may reach the first best solution while issuing debt or equity to outsiders provided that either the insiders receive a senior claim or that the firm hedges. We then show that given asymmetric information concerning costs the only viable solution has the firm issuing debt to outsiders and hedging.

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Article provided by Elsevier in its journal Journal of Financial Stability.

Volume (Year): 6 (2010)
Issue (Month): 2 (June)
Pages: 55-63

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Handle: RePEc:eee:finsta:v:6:y:2010:i:2:p:55-63
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  1. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
  2. Luigi Zingales, 2000. "In Search of New Foundations," NBER Working Papers 7706, National Bureau of Economic Research, Inc.
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  10. Stewart C. Myers & Nicholas S. Majluf, 1984. "Corporate Financing and Investment Decisions When Firms Have InformationThat Investors Do Not Have," NBER Working Papers 1396, National Bureau of Economic Research, Inc.
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  13. Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  14. Froot, Kenneth A & Scharfstein, David S & Stein, Jeremy C, 1993. " Risk Management: Coordinating Corporate Investment and Financing Policies," Journal of Finance, American Finance Association, vol. 48(5), pages 1629-58, December.
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  17. Gerald D. Gay & Jouahn Nam, 1998. "The Underinvestment Problem and Corporate Derivatives Use," Financial Management, Financial Management Association, vol. 27(4), Winter.
  18. Stulz, René M., 1984. "Optimal Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 19(02), pages 127-140, June.
  19. Hassan Naqvi, 2004. "The Valuation of Corporate Debt with Default Risk," Finance 0410010, EconWPA.
  20. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
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