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Capital Structure and Seniority in Entrepreneurial Firms

Author

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  • Filippo Ippolito

Abstract

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.

Suggested Citation

  • Filippo Ippolito, 2005. "Capital Structure and Seniority in Entrepreneurial Firms," Economics Series Working Papers 2005-FE-12, University of Oxford, Department of Economics.
    • Handle: RePEc:oxf:wpaper:2005-fe-12
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    File URL: https://ora.ox.ac.uk/objects/uuid:0e4e918c-d2b6-4ca9-b351-c4f076136724
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    More about this item

    Keywords

    Bank; Venture capital; Monitoring; Liquidation; Seniority; Convertible debt;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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