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The Choice Between Bank Debt and Equity

Author

Listed:
  • Lars Jebjerg

    (Institute of Economics, University of Copenhagen)

  • Søren Kyhl

    (Institute of Economics, University of Copenhagen)

Abstract

: This paper develops a model of financing choice by an entrepreneur about to undertake a project. The entrepreneur is essential for the project but cash-constrained. Thus, he must sell part of the project to outside investors, while remaining in control as a manager. To finance the project he can sell shares to outside equityholders or approach a bank for a loan. The optimal financial structure trades-off an efficient project choice and efficient effort levels. Equity financing does not directly distort the project choice but has a distortionary effect on effort, which in turn may lead to an inefficient choice of project. Bank financing may lead to an inefficient project choice but creates only little effort distrotion for a given project. It is shown that the optimal financial structure varies with project characteristics and the external financing requirement.

Suggested Citation

  • Lars Jebjerg & Søren Kyhl, 1999. "The Choice Between Bank Debt and Equity," Discussion Papers 99-18, University of Copenhagen. Department of Economics.
    • Handle: RePEc:kud:kuiedp:9918
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    Cited by:

    1. Charles Ka Yui Leung & Edward Chi Ho Tang, 2015. "Speculating China Economic Growth through Hong Kong? Evidence from Stock Market IPOs and Real Estate Markets," International Real Estate Review, Global Social Science Institute, vol. 18(1), pages 45-87.

    More about this item

    Keywords

    corporate finance; capital structure; banks;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • 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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