Heterogeneous Beliefs, Moral Hazard, and Capital Structure

Schmalenbach Business Review, Vol. 55, April 2003

Posted: 16 Jul 2003  

Jochen Bigus

Free University Berlin, Department Accounting and Finance

Abstract

This paper provides a new approach to the theory of capital structure by emphasizing the issue that investors and entrepreneurs may have heterogeneous beliefs on future firms returns. Heterogeneous beliefs are possible even when there is symmetric information but individuals evaluate the same information differently. Although heterogeneous beliefs might be an important issue in real life, corporate finance theory hardly addresses them. When heterogeneous beliefs and moral hazard exist, a debt-equity mix might outperform pure debt or pure equity. I examine a situation in which there is perk consumption (which favors debt) and heterogeneous beliefs on project risk (which favors equity in case of risk neutrality) and heterogeneous beliefs on the project's mean (which favors debt). Optimal contracts tend to be highly nonlinear with heterogeneous beliefs.

Keywords: Behavioral Finance, Corporate Finance, Heterogeneous Beliefs, Moral Hazard

JEL Classification: G31, G24

Suggested Citation

Bigus, Jochen, Heterogeneous Beliefs, Moral Hazard, and Capital Structure. Schmalenbach Business Review, Vol. 55, April 2003. Available at SSRN: https://ssrn.com/abstract=406463

Jochen Bigus (Contact Author)

Free University Berlin, Department Accounting and Finance ( email )

Kaiserswerther Str. 16-18
Berlin, Berlin 14195
Germany
++49-30-83852509 (Phone)

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