Capital Structure under Costly Enforcement* |
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Authors: | Hans K. Hvide Tore Leite |
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Affiliation: | 1. University of Aberdeen Business School, Old Aberdeen AB24 3QY, Scotland hans.hvide@abdn.ac.uk;2. Norwegian School of Economics and Business Administration, N‐5045 Bergen, Norway tore.leite@nhh.no |
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Abstract: | We consider financial structure and repayment behavior in a setting where cash flows are private information to the entrepreneur and the cost of enforcing repayment differs across security holders. If enforcement costs are lower for shareholders than for creditors, a mixed capital structure with debt and equity can obtain in equilibrium. Under a mixed capital structure, creditors intervene in low cash‐flow states while shareholders intervene in high cash‐flow states. Moreover, strategic defaults, costly bankruptcy, shareholder intervention, and violation of absolute priority occur with positive probability on the equilibrium path. Several of the predictions from our framework are consistent with evidence not readily explainable by existing theories. |
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Keywords: | Absolute priority cash diversion costly state verification financial contracts outside equity strategic defaults G21 G33 G34 G35 |
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