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Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/27209
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| Title: | Capital Structure Decisions in Small and Large Firms: A Life-cycle
Theory of Financing |
| Authors: | Fluck, Zsuzsanna |
| Keywords: | security design
nonverifiability of cash flow
managerial moral hazard
control rights,
maturity
managerial dismissal,
asset liquidation,
capital structure. |
| Issue Date: | 31-Oct-1999 |
| Series/Report no.: | FIN-99-069 |
| Abstract: | Abstract This paper focuses on the dynamic capital structure of
firms: Why firms choose very different capital structure in different
stages of their life-cycles? In a model of optimal financial
contracting, we investigate whether subsequent financing decisions of
firms are affected by the outcome of previous financing decisions. We
find that the initial and subsequent financing decisions of the same
firm may lead to different security choices. The firms' financing
decisions will differ in two respect. First, there will be equilibrium
contracts that investors would reject for some small firm, but accept
them for an otherwise identical large firm (i.e. when the two firms have
identical projects). Secondly, even the set of the equilibrium financial
contracts differs in different stages of the firm's lifecycle: some
contracts which are never sustainable as an initial contract for a small
firm become sustainable for large firms. The reason is the
stage-dependency of the control rights of subsequent claimholders: in
addition to their own rights, holders of subsequent security issues may
also rely on the firm's existing investors to enforce their claims.
Whether or not they can do so, depends on the priority structure of the
claims. Consistent with empirical evidence, our theory implies a
life-cycle pattern of financing: firms will issue outside equity,
short-term debt or convertible debt first, then use their retained
earnings, issue longer-term debt, or outside equity to satisfy
sub-sequent financing needs. A novel result of our analysis is that,
despite the presence of severe market imperfections, the
Modigliani-Miller indifference result between debt and equity does hold
for large firms in our model, but at the same time, it fails to hold for
small firms. The intuition is again the interaction between the control
rights of subsequent claimholders. Since the control rights of previous
securityholders represent an externality for subsequent claimholders,
the marginal decision of which security to issue next becomes irrelevant
once a firm has sufficient contractual complexity in place. |
| URI: | http://hdl.handle.net/2451/27209 |
| Appears in Collections: | Finance Working Papers
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