Equity, Bonds, and Bank Debt: Capital Structure and Financial Market Equilibrium Under Asymmetric Information

Posted: 30 Mar 2000

See all articles by Patrick Bolton

Patrick Bolton

Columbia Business School - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Xavier Freixas

Universitat Pompeu Fabra; Centre for Economic Policy Research (CEPR); Barcelona Graduate School of Economics (Barcelona GSE)

Abstract

This paper proposes a model of financial markets and corporate finance, with asymmetric information and no taxes, where equity issues, bank debt, and bond financing coexist in equilibrium. The relationship banking aspect of financial intermediation is emphasized: firms turn to banks as a source of investment mainly because banks are good at helping them through times of financial distress. This financial flexibility is costly since banks face costs of capital themselves (which they attempt to minimize through securitization). To avoid this intermediation cost, firms may turn to bond or equity financing, but bonds imply an inefficient liquidation cost and equity an informational dilution cost. We show that in equilibrium the riskier firms prefer bank loans, the safer ones tap the bond markets, and the ones in between prefer to issue both equity and bonds. This segmentation is broadly consistent with stylized facts.

JEL Classification: G21, G32

Suggested Citation

Bolton, Patrick and Freixas, Xavier, Equity, Bonds, and Bank Debt: Capital Structure and Financial Market Equilibrium Under Asymmetric Information. Journal of Political Economy, Vol. 108, No. 2, April 2000. Available at SSRN: https://ssrn.com/abstract=212922

Patrick Bolton (Contact Author)

Columbia Business School - Department of Economics ( email )

420 West 118th Street
New York, NY 10027
United States

HOME PAGE: http://www0.gsb.columbia.edu/faculty/pbolton/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Xavier Freixas

Universitat Pompeu Fabra ( email )

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
+34 93 542 2726 (Phone)
+34 93 542 1746 (Fax)

HOME PAGE: http://www.econ.upf.es/~freixas

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

HOME PAGE: http://www.econ.upf.es/~freixas/more/personal1.htm

Barcelona Graduate School of Economics (Barcelona GSE) ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

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