Capital Structure Under Costly Enforcement

46 Pages Posted: 24 Jun 2002 Last revised: 15 Feb 2008

See all articles by Tore E. Leite

Tore E. Leite

Norwegian School of Economics (NHH)

Hans K. Hvide

University of Bergen - Department of Economics; University of Aberdeen - Business School; Centre for Economic Policy Research (CEPR); Institute for the Study of Labor (IZA)

Date Written: February 13, 2008

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 differ 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 the framework are consistent with evidence not readily explainable with existing theories.

Note: Previously Entitled : Strategic Defaults and Priority Violations under Costly State Verification

Keywords: Absolute priority, cash diversion, costly state verification, financial contracts, outside equity, strategic defaults

JEL Classification: G21, G33, G34, G35

Suggested Citation

Leite, Tore E. and Hvide, Hans, Capital Structure Under Costly Enforcement (February 13, 2008). Available at SSRN: https://ssrn.com/abstract=313821 or http://dx.doi.org/10.2139/ssrn.313821

Tore E. Leite

Norwegian School of Economics (NHH) ( email )

Helleveien 30
N-5045 Bergen
Norway
+47 5595 9343 (Phone)
+47 5595 9841 (Fax)

Hans Hvide (Contact Author)

University of Bergen - Department of Economics ( email )

Fosswinckelsgt. 6
N-5007 Bergen, 5007
Norway

University of Aberdeen - Business School ( email )

Edward Wright Building
Dunbar Street
Aberdeen, Scotland AB24 3QY
United Kingdom

HOME PAGE: http://hans.hvide.googlepages.com/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Institute for the Study of Labor (IZA) ( email )

P.O. Box 7240
Bonn, D-53072
Germany

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