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Capital Structure and Seniority in Entrepreneurial Firms

  • Filippo Ippolito
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    We present a model of cash constrained entrepreneurs who need an investor to finance their project. Investors can either be uninformed, such as individual bondholders, or informed, such as venture capitalists and banks. There is an entrepreneurial moral hazard problem, which can be partially overcome through monitoring only by informed investors. However, monitoring is only effective if investors can commit ex ante to liquidate the project after observing a poor signal. We show that a capital structure that minimizes commitment and information costs requires informed investors to hold senior convertible debt, uninformed investors to hold junior debt and entrepreneurs to hold common stock.

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    Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 2005-FE-12.

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    Date of creation: 01 Oct 2005
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    Handle: RePEc:oxf:wpaper:2005-fe-12
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