A Theory of Asset- and Cash Flow-Based Financing

75 Pages Posted: 31 Jan 2022 Last revised: 16 Apr 2023

Date Written: January 2022

Abstract

We develop a dynamic contracting theory of asset- and cash flow-based financing that demonstrates how firm, intermediary, and capital market characteristics shape firms’ financing constraints. A firm with imperfect access to equity financing covers financing needs through costly sources—an intermediary and retained cash. The firm’s financing capacity is endogenously determined by either the liquidation value of assets (asset-based) or the intermediary’s going-concern valuation of the firm’s cash flows (cash flow-based). We implement the optimal contract between the firm and intermediary with both unsecured and secured debt (credit lines) in an overlapping pecking order: the firm simultaneously finances cash flow shortfalls with unsecured debt and either cash reserves (if available) or secured debt (otherwise). Improved access to equity financing increases debt capacity, thus debt and equity are dynamic complements. When the firm does well, it repays its debt in full, while when in distress, repayment dynamics mirror U.S. bankruptcy procedures.

Suggested Citation

Hartman-Glaser, Barney and Mayer, Simon and Milbradt, Konstantin, A Theory of Asset- and Cash Flow-Based Financing (January 2022). NBER Working Paper No. w29712, Available at SSRN: https://ssrn.com/abstract=4021807

Barney Hartman-Glaser (Contact Author)

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Simon Mayer

Carnegie Mellon University ( email )

Pittsburgh, PA 15213-3890
United States

Konstantin Milbradt

Northwestern University - Kellogg School of Management - Department of Finance ( email )

Evanston, IL 60208
United States

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