The Debt-Equity Distinction
Banking and Finance Law Review, Vol. 26
22 Pages Posted: 21 Jan 2011 Last revised: 26 Aug 2011
Date Written: January 20, 2011
The distinction between debt and equity often is crucially important. Yet some doubt that there is a distinction of kind, or that the distinction is certain. My objective is to illuminate the conventional view of the difference – the imparity between fixed and contingent participation – and address the main challenges it has encountered. I first describe the common law and statutory developments that crystallized the distinction. I then review the entangled criticisms: that debt and equity are functionally equivalent or that the difference between them is fatally uncertain. Finally, I briefly consider the utility of the distinction in specific contexts.
Keywords: Debt, Equity, Debt-Equity, Finance, Finance Theory, Capital Structure Irrelevance Principle, Trade-Off Theory, Pecking Order, Free Cash Flow, Option, Tax, Factors, Functional Equivalence, Profit-Sharing, Debt-Equity Ratio, Contingency, Viability Risk, Default Risk, Insolvency Risk, Preference Share
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