Equity-Debtholder Conflicts and Capital Structure

30 Pages Posted: 17 Mar 2010  

Per Strömberg

Swedish House of Finance

Bo Becker

Stockholm School of Economics; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: February 17, 2010

Abstract

We use an important legal event as a natural experiment to examine equity-debt conflicts in the vicinity of financial distress. A 1991 Delaware bankruptcy ruling changed the nature of corporate directors’ fiduciary duties in that state. This change limited incentives to take actions favoring equity over debt. We show that, as predicted, this increased the likelihood of equity issues, increased investment, and reduced risk taking. The changes are isolated to indebted firms (where the legal change applied). These reductions in agency costs were followed by an increase in average leverage and a reduction in interest costs. Finally, we can estimate the welfare implications of agency costs, because firm values increased when the rules were introduced. We conclude that equity-bond holder conflicts are economically important, determine capital structure choices, and affect welfare.

Keywords: Bankruptcy, Costs of Financial Distress, Capital Structure

JEL Classification: G32, G33, L2

Suggested Citation

Strömberg, Per and Becker, Bo, Equity-Debtholder Conflicts and Capital Structure (February 17, 2010). AFA 2011 Denver Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1572641 or http://dx.doi.org/10.2139/ssrn.1572641

Per Stromberg

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

Bo Becker (Contact Author)

Stockholm School of Economics ( email )

Drottninggatan 98
Dept. of Finance
111 60 Stockholm, 11160
Sweden

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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