Fitting the glass slipper: optimal capital structure in the face of liability
The model presented in this paper juxtaposes two theories for why a firm might offer creditors a security interest to back up a loan. One theory holds that issuing secured debt allows the firm's owners to reduce expected payments in the event of bankruptcy to so-called "non-adjusting" creditors, who cannot or do not adjust the size of their claims in response. An important class of such non-adjusting claims are liability claims on the firm. The other theory holds that issuing secured debt solves an underinvestment problem: the firm may only be able to finance a growth opportunity if it offers new investors a security interest. Recognizing that most real-world firms face both non-adjusting claims and growth opportunities, we combine the two theories in a single model. We find that firms generally choose an interior secured-debt ratio, and all firms smaller than a critical size choose a strictly higher secured-debt ratio than firms larger than the critical size. Moreover, the relationship between the optimal secured-debt ratio and firm size is highly nonlinear in ways consistent with the empirical evidence: the optimal ratio mayor may not initially increase in firm size, then tends to decrease, and then becomes constant.
|Date of creation:||01 Oct 2000|
|Contact details of provider:|| Postal: 207 Giannini Hall #3310, Berkeley, CA 94720-3310|
Phone: (510) 642-3345
Fax: (510) 643-8911
Web page: http://www.escholarship.org/repec/are_ucb/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Barclay, Michael J & Smith, Clifford W, Jr, 1995. " The Priority Structure of Corporate Liabilities," Journal of Finance, American Finance Association, vol. 50(3), pages 899-917, July.
- Hudson, John, 1995. "The case against secured lending," International Review of Law and Economics, Elsevier, vol. 15(1), pages 47-63, January.
- Schwartz, Alan, 1989. "A Theory of Loan Priorities," The Journal of Legal Studies, University of Chicago Press, vol. 18(2), pages 209-261, June.
- Alan Schwartz, 1997. "Priority Contracts and Priority in Bankruptcy," Yale School of Management Working Papers ysm72, Yale School of Management.
- Triantis, George G, 1992. "Secured Debt under Conditions of Imperfect Information," The Journal of Legal Studies, University of Chicago Press, vol. 21(1), pages 225-258, January.
- 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.
- Stulz, ReneM. & Johnson, Herb, 1985. "An analysis of secured debt," Journal of Financial Economics, Elsevier, vol. 14(4), pages 501-521, December.
- Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
When requesting a correction, please mention this item's handle: RePEc:cdl:agrebk:qt5nb497vk. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Lisa Schiff)
If references are entirely missing, you can add them using this form.