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Property Rights, Risk and Leverage

Author

Listed:
  • Graff, Richard A.

    (Electrum Partners L.L.C.)

  • Kairys, Jr. Joseph P.

    (Department of Economics, School of Economics and Commercial Law, Göteborg University)

Abstract

Risk matters when corporate debt has a positive probability of default. Lenders have traditionally used covenants to protect their property rights because the financing and operating decisions of firms can reduce the value of the firm’s outstanding debt. We examine the use of captive finance subsidiaries and special purposed entities (SPEs) to partition default risk within the firm. A more complex arrangement of property rights within the firm allows the parent firm to retain operating flexibility while offering lenders better protection. We conclude that capital structure is a relevant decision variable for corporate managers because firms are able to obtain leveraged finance at a lower cost when risk is partitioned using separate legal structures within the firm.

Suggested Citation

  • Graff, Richard A. & Kairys, Jr. Joseph P., 2005. "Property Rights, Risk and Leverage," Working Papers in Economics 183, University of Gothenburg, Department of Economics.
    • Handle: RePEc:hhs:gunwpe:0183
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    File URL: http://hdl.handle.net/2077/2711
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    Keywords

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    JEL classification:

    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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