67 Pages Posted: 13 Jan 2012 Last revised: 23 Mar 2012
Date Written: March 22, 2012
The nature of the firm and its financing are closely interlinked. To produce significant net present value, an entrepreneur has to transform her enterprise into one that is differentiated from the ordinary. To achieve the control that will allow her to execute this strategy, she needs to have substantial ownership, and thus financing. But it is hard to raise finance against differentiated assets. So an entrepreneur has to commit to undertake a second transformation, standardization, that will make the human capital in the firm, including her own, replaceable, so that outside financiers obtain rights over going-concern surplus. I argue that the availability of a vibrant stock market helps the entrepreneur commit to these two transformations in a way that a debt market would not. This helps explain why the nature of firms and the extent of innovation differ so much in different financing environments.
JEL Classification: G32, L22, L26
Suggested Citation: Suggested Citation
Rajan, Raghuram G., The Corporation in Finance (March 22, 2012). Chicago Booth Research Paper No. 12-02; Fama-Miller Working Paper; IGM Working Paper No. 69. Available at SSRN: https://ssrn.com/abstract=1983992 or http://dx.doi.org/10.2139/ssrn.1983992