Capital Structure Decisions in Small and Large Firms: A Life-Cycle Theory of Financing
51 Pages Posted: 4 Nov 2008
Date Written: July 2000
This paper focuses on the dynamic capital structure of firms: Why do firms use verydifferent financial contracts in different stages of their life-cycles? In a model of optimal financial contracting, we investigate whether firms' subsequent financing decisions are affected by the outcome of their previous financing decisions. We find that the initialand subsequent financing decisions of the same firm may lead to different securitychoices. The firms' financing decisions will differ in two respect. First, there will beequilibrium contracts that investors would reject for some startup firm, but wouldaccept for an otherwise identical ongoing ¯rm (i.e. even when the two firms have identical projects). Secondly, even the set of the equilibrium financial contracts differsin different stages of the firm's lifecycle: some contracts which are never sustainableas an initial contract but become sustainable as a subsequent contract. The reasonis the stage-dependency of the control rights of subsequent claimholders: in additionto their own rights, holders of subsequent security issues may also rely on the firm'sexisting investors to enforce their claims. Whether or not they can do so, depends onthe priority structure of the claims.
Keywords: security design, nonveri¯ability of cash °ows, managerial moral hazard, control rights, maturity, maturity, maturity, capital structure
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