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Debt and Seniority: An Analysis of the Role of Hard Claims in Constraining Management

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Author Info
Oliver Hart
John Moore

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Abstract

We argue that long-term debt has a role in controlling management's ability to finance future investments. A company with high (widely-held) debt will find it hard to raise capital, since new security holders will have low priority relative to existing creditors. Conversely for a company with low debt. We show there is an optimal debt-equity ratio and mix of senior and junior debt if management undertakes unprofitable as well as profitable investments. We derive conditions under which equity and a single class of senior long-term debt work as well as more complex contracts for controlling investment behavior.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4886.

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Date of creation: Aug 1995
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Handle: RePEc:nbr:nberwo:4886

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Find related papers by JEL classification:
D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data

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This page was last updated on 2009-11-7.

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