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Debt, hedging, and human capital

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  • Stephen D. Smith
  • Larry D. Wall

Abstract

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.

Suggested Citation

  • Stephen D. Smith & Larry D. Wall, 2005. "Debt, hedging, and human capital," FRB Atlanta Working Paper 2005-30, Federal Reserve Bank of Atlanta.
    • Handle: RePEc:fip:fedawp:2005-30
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    References listed on IDEAS

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