Debt and Seniority: An Analysis of the Role of Hard Claims in Constraining Management

56 Pages Posted: 9 Nov 2011

See all articles by Oliver Hart

Oliver Hart

Harvard University - Department of Economics; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

John Moore

University of Edinburgh - Economics; London School of Economics

Date Written: October 1994

Abstract

We argue that long-term debt has a role in controlling management's ability to finance future investments. A company with high (widely-held) debt will find it hard to raise capital, since new security holders will have low priority relative to existing creditors. Conversely for a company with low debt. We show there is an optimal debt-equity ratio and mix of senior and junior debt if management undertakes unprofitable as well as profitable investments. We derive conditions under which equity and a single class of senior long-term debt work as well as more complex contracts for controlling investment behavior.

Suggested Citation

Hart, Oliver D. and Moore, John Hardman, Debt and Seniority: An Analysis of the Role of Hard Claims in Constraining Management (October 1994). NBER Working Paper No. w4886, Available at SSRN: https://ssrn.com/abstract=1956994

Oliver D. Hart (Contact Author)

Harvard University - Department of Economics ( email )

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John Hardman Moore

University of Edinburgh - Economics ( email )

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