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A Theory of Cash Flow-Based Financing with Distress Resolution

Author

Listed:
  • Barney Hartman-Glaser
  • Simon Mayer
  • Konstantin Milbradt

Abstract

We develop a dynamic contracting theory of asset- and cash flow-based financing that demonstrates how firm, intermediary, and capital market characteristics jointly shape firms’ financing constraints. A firm with imperfect access to equity financing covers financing needs through costly sources: an intermediary and retained cash. The firm’s financing capacity is endogenously determined by either the liquidation value of assets (asset-based) or the intermediary’s going-concern valuation of the firm’s cash flows (cash flow-based). The optimal contract is implemented with defaultable debt — specifically unsecured credit lines and senior-secured debt — and features risk-sharing via bankruptcy. When the firm does well, it repays its debt in full. When it does poorly, distress resolution mirrors U.S. bankruptcy procedures (Chapter 7 and 11). Secured and unsecured debt are complements because risk-sharing via unsecured debt increases secured debt capacity. Debt and equity are dynamic complements because future access to equity financing increases current debt capacity.

Suggested Citation

  • Barney Hartman-Glaser & Simon Mayer & Konstantin Milbradt, 2022. "A Theory of Cash Flow-Based Financing with Distress Resolution," NBER Working Papers 29712, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:29712
    Note: CF
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    More about this item

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy

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