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Optimal Financial Structure: An Incomplete Contracting Model

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  • Tore Leite

Abstract

The financial structures of firms observed in practice typically consist of debt claims of different priority and maturity, and outside equity with unconditional control. A simple model is developed in which this type of complex financial structure arises endogenously as a mechanism to allocate control and cash flow rights among the firm's manager and its investors. While short‐term debt commits the manager to liquidate the firm in low profit states, outside equity with unconditional control allows investors to seize control in states where the manager otherwise would pursue low profit projects with high private benefits of control. Finally, long‐term (junior) debt creates a debt overhang that protects the manager from excessive shareholder involvement. JEL classification: G32

Suggested Citation

  • Tore Leite, 2001. "Optimal Financial Structure: An Incomplete Contracting Model," Scandinavian Journal of Economics, Wiley Blackwell, vol. 103(4), pages 707-722, December.
    • Handle: RePEc:bla:scandj:v:103:y:2001:i:4:p:707-722
    DOI: 10.1111/1467-9442.00267
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    Cited by:

    1. Pierre M. Picard & Ridwan D. Rusli, 2018. "State‐owned firms and private debt," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 20(5), pages 672-702, October.

    More about this item

    JEL classification:

    • 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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