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The Financing and Redeployment of Specific Assets

Posted: 11 Nov 1998  

Michel A. Habib

University of Zurich; Swiss Finance Institute

D. Bruce Johnsen

George Mason University - School of Law; PERC - Property and Environment Research Center

Abstract

We model the role various forms of nonrecourse secured debt play in efficiently allocating control rights over assets whose value is state-specific. Ex ante, the entrepreneur makes a noncontractable investment that is specific to the best use of the asset in the status quo, or good, states. The lender makes a noncontractable investment in redeployment that is specific to the next best use of the asset in the bad states. The face amount of the loan is chosen to equal the value of the asset in the critical state that separates the good and bad states, with the loan being secured by the asset. If a good state prevails, the entrepreneur maintains control and captures the entire surplus from his use of the asset. If a bad state prevails, he defaults and relinquishes the asset because it is worth less to him than his obligation under the loan. The lender then redeploys the asset to its next best alternative use and captures the entire surplus from doing so. This state-contingent transfer of control avoids the ex post bargaining that wold otherwise split the redeployment surplus between the parties and distort their ex ante specific investments. Unlike other prominent models of financial contracting, ours imposes no wealth constraint on the entrepreneur and requires no intermediate signal to identify the ex post state of the world. Moreover, it is consistent with a wide range of financial practices including financial leasing, real options, vendor financing, secured and unsecured debt, project finance, and the general pattern of debt priorities and their disposition in bankruptcy.

JEL Classification: G31, G32

Suggested Citation

Habib, Michel A. and Johnsen, D. Bruce, The Financing and Redeployment of Specific Assets. Journal of Finance, Vol. 20, No. 20, 1998. Available at SSRN: https://ssrn.com/abstract=138188

Michel A. Habib

University of Zurich ( email )

Plattenstrasse 14
Zurich, 8032
Switzerland
41-44-634-2507 (Phone)
41-44-634-4903 (Fax)

HOME PAGE: http://www.isb.uzh.ch/institut/profs/mhabib.htm

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

D. Bruce Johnsen (Contact Author)

George Mason University - School of Law ( email )

3301 Fairfax Drive
Arlington, VA 22201
United States
703-993-8066 (Phone)
703-993-8088 (Fax)

PERC - Property and Environment Research Center

2048 Analysis Drive
Suite A
Bozeman, MT 59718
United States

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