Discussion Paper No. 41
November 3, 2021
The Commitment Role of Equity Financing
Author:
Abstract:
Existing theories of a firm’s optimal capital structure seem to fail in explaining why many healthy and profitable firms rely heavily on equity financing, even though benefits associated with debt (like tax shields) appear to be high and the bankruptcy risk low. This holds in particular for firms that show a strong commitment towards their workforce and are popular among employees. We demonstrate that such financing behavior may be driven by implicit arrangements made between a firm and its managers/employees. Equity financing generally strengthens a firm’s credibility to honor implicit promises. Debt, however, has an adverse effect on the enforceability of these arrangements because too much debt increases the firm’s reneging temptation, as some of the negative consequences of breaking implicit promises can be shifted to creditors. Our analysis provides an explanation for why some firms only use little debt financing. Predictions made by our theory are in line with a number of empirical results, which seem to stay in contrast to existing theories on capital structure.
Keywords:
relational contracts; capital structure; corporate finance; debt financing;
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Discussion Paper No. 6
November 2, 2021
Long-Term Employment Relations when Agents Are Present Biased
Author:
Abstract:
We analyze how agents’ present bias affects optimal contracting in an infinite- horizon employment setting. The principal maximizes profits by offering a menu of contracts to naive agents: a virtual contract – which agents plan to choose in the future – and a real contract which they end up choosing. This virtual contract motivates the agent and allows the principal to keep the agent below his outside option. Moreover, under limited liability, implemented effort can be inefficiently high. With a finite time horizon, the degree of exploitation of agents decreases over the life-cycle. While the baseline model abstracts from moral hazard, we show that the result persists also when allowing for non-contractible effort.
Keywords:
employment relations; dynamic contracting; present bias;
JEL-Classification: