|
Archive@NYU >
Stern School of Business >
Finance Working Papers >
Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/27120
|
| Title: | The Optimality of Debt versus Outside Equity |
| Authors: | Fluck, Zsuzsanna |
| Keywords: | security design
non-verifiability of cash flows
managerial moral hazard
debt
outside equity
capital structure |
| Issue Date: | 10-Dec-1995 |
| Series/Report no.: | FIN-95-020 |
| Abstract: | This paper presents a theory of outside equity based on the control
rights and the maturity design of equity. We show that outside equity is
a tacit agreement between investors and management supported by
equityholders’ right to dismiss management regardless of
performance and by the lack of a prespecified expiration date on equity.
Furthermore, as a tacit agreement outside equity is sustainable despite
management’s potential for manipulating or diverting the cash
flows and regardless of how costly it is for equityholders to establish
a case against managerial wrongdoing. We establish that the only outside
equity hat investors are willing to hold in equilibrium is outside
equity with unlimited life, the very outside equity that corporations
issues. Consistent with empirical evidence, this model predicts that
debt-equity ratios will be higher in industries where cash flow
variability is low relative to industries where cash flow variability is
high. Furthermore, our theory implies that investors practice maturity-
matching: they match the maturity of the optimal debt contract with the
life of the physical assets and the maturity of the equity contract with
the life of the company’s real options. |
| URI: | http://hdl.handle.net/2451/27120 |
| Appears in Collections: | Finance Working Papers
|
All items in Faculty Digital Archive are protected by copyright, with all rights reserved.
|
