Учебный год 22-23 / Firms, Contracts, and Financial Structure

Note, however, that this effect disappears if the manager is on an incentive scheme such as (6.7) (and he is forbidden from holding additional shares). Under these conditions his total reward depends only on the firm's ex post total value—y1+y2 or y1+L—and not on the split between shareholders and creditors. Thus, the manager no longer has any incentive to issue debt rather than equity.167

Finally, consider the view that firms issue debt in order to ‘complete’ the market (see e.g. Stiglitz 1974, and Allen and Gale 1994). The idea behind this is that risk-averse investors may be interested in holding claims conditional on a firm's profit, other than just shares, in the absence of a full set of Arrow–Debreu securities. The firm can cater to such investors by issuing risky debt as well as equity and can thereby raise its market value.

There are two difficulties with this as a theory of capital structure, however. First, it is not clear why the firm has to issue these more complicated claims itself; other traders in the market can and do issue such ‘derivative’ claims. Second, if the purpose of these claims is solely to enrich the available investment opportunities, why does a failure to make a payment to creditors trigger the firm's default and bankruptcy; i.e., why doesn't the firm issue preferred shares that specify that claim-holders are owed a fixed amount, but that the firm can pay out less in the absence of a dividend to shareholders? Preferred shares offer the same return stream as risky debt if the manager is selfless; however, they have the great advantage that they avoid the inefficiency costs of bankruptcy.

>This section—and the chapter as a whole—can be summed up as follows. Taxes, asymmetric information, and incomplete markets are all undoubtedly important influences on the choice of a firm's capital structure. However, these factors alone cannot explain why debt has the feature that it is senior and that a failure to pay leads to a penalty in the form of bankruptcy, i.e. why debt is associated with a ‘hard’ budget constraint.168 At the risk of belabouring

167This observation has also been made by Dybvig and Zender (1991). The above discussion does not do full justice to the Myers–Majluf model (or to other asymmetric information theories of debt). For a fuller account, see Hart (1993).

168A qualification should be made. Some writers have argued that, even if the management is selfless, senior debt may be useful as a way of bonding the firm if it engages in

strategic behaviour in product markets or in bargaining with unions; see Baldwin (1983), Brander and Lewis (1986), and Perotti and Spier (1993). Although strategic effects may well be important, however, it would be surprising if they alone could explain the widespread use of (senior) debt or the variations in debt across industries, countries, or over time. On the latter, see Rajan and Zingales (1994).

the obvious, note that the theory developed in this chapter does explain these facts. If debt were postponable, the manager would never be forced to liquidate in model 1 or to pay out free cash flow in model 3. If debt were junior, the manager could finance an unprofitable investment in models 2 and 3 by issuing debt at date 1 that was senior to existing debt.

The conclusion is that, although the agency approach may not be the whole story, it would seem to be an essential part of any fully developed theory of capital structure.169

169One weakness of the models I have presented in this chapter is that they do not explain why firms issue dividends. In these models, the managers always (weakly) prefer to retain profits and use them to build a bigger empire. (Shareholders receive a ‘liquidating’ dividend at date 2, but only because by assumption the firm is wound up.) One way to explain dividends is to drop the assumption that shareholders are completely passive. The manager may then pay a dividend in order to deter a large shareholder or a take-over bidder from intervening in the company's affairs. In fact, the debt-equity swaps considered in §5 had this character. Developing a convincing model of dividend behaviour is a very important topic for future research.

and the expected return to initial security holders is

Option 1 is preferred to option 2 if and only if it generates a lower value of (totally unprofitable) investment, i.e. if and only if

Triggering bankruptcy.

Consider next the second choice, which is to trigger bankruptcy in state B. Under these conditions, it is optimal to set to avoid slack in state A. The return to initial security holders is then

The final step of subcase 2 is to compare the values of R from avoiding bankruptcy and triggering bankruptcy. The results for subcase 2 overall are summarized in (6A.3)–(6A.5). (To obtain the results for model 3 overall, one must combine (6A.3)–(6A.5) with subcase 1, which is concerned with the situation .)(6A.3)

That is, total debt is set such that the firm just avoids bankruptcy in state B by borrowing, but the firm has enough debt capacity in state A to make an unprofitable investment.

control to (all the) creditors’ means. In the absence of a formal bankruptcy procedure, the law provides a creditor with two main remedies in the event of a default. First, with regard to a secured loan, the creditor can seize the assets that serve as collateral for the loan. Second, with regard to an unsecured loan, the creditor can sue the debtor and call on a sheriff to enforce the court's judgment, possibly by selling the debtor's assets (see Baird and Jackson 1985).

Difficulties arise when the debtor has insufficient assets to cover his liabilities (which is very likely to be the case—otherwise why would the debtor have gone bankrupt?). Creditors may then engage in a socially wasteful race to be first to seize their collateral or to obtain a judgment against the debtor.172 Also—and perhaps more important—this race may lead to the dismantlement of the debtor's assets and to a loss of value for all creditors if these assets are worth more as a whole than as a collection of pieces.

Given this, it is in the collective interest of creditors that the disposition of the debtor's assets be carried out in an orderly manner. This is the rationale for a formal bankruptcy procedure.

Nothing so far implies that the formal bankruptcy procedure needs to be provided by the state rather than by the parties themselves. In a world of costless contracting, debtors and creditors would anticipate the possibility of default and the consequent collective action problems and specify as part of their initial contract what should happen in a default state—in particular, whether the company should be reorganized or liquidated and how its value should be divided up among various claimants.

In practice, transaction costs may be too large for debtors and creditors to design their own bankruptcy procedure contractually, particularly in situations where debtors acquire new assets and new creditors as time passes. Instead, parties may prefer to rely on a ‘standard form’ state-provided bankruptcy procedure. It is a long way from this observation, however, to any conclusions about the nature of an optimal standard-form procedure. The problem is that a satisfactory analysis of an optimal procedure requires a theory both of why contracts are incomplete, and of how the state can overcome this incompleteness. Chapters 2–4 shed some light on the first of these questions, but not on the second.

172 See Jackson (1986). The race to be first is a negative-sum game since wins and losses cancel out and everybody spends resources to play the game.

In particular, in Chapters 2–4 contractual incompleteness was the result of the courts' inability to observe variables that the parties could observe. Thus, the courts were the source of contractual incompleteness rather than the solution.173

In what follows, therefore, optimal bankruptcy procedure is not derived from first principles. Instead, some goals that an efficient bankruptcy procedure should satisfy are suggested, and a procedure is described that does a reasonable job of meeting these goals. It will be argued that the procedure presented is practical and avoids some of the pitfalls of existing procedures. Also, the procedure is sufficiently simple and natural that future work may show it to be optimal within a reasonable class of procedures.174

2.Goals of a Bankruptcy Procedure

As mentioned above, the analysis does not proceed from first principles. However, economic theory suggests that the following are desirable goals for a bankruptcy procedure.

1.A good bankruptcy procedure should achieve an ex post efficient outcome (that is, an outcome that maximizes the total value of the proceeds—measured in money terms—received by the existing claimants).175

2.A good bankruptcy procedure should preserve the (ex ante) bonding role of debt by penalizing managers adequately in bankruptcy states. However, bankruptcy should not be so

173For a further discussion of this, see Hart (1990). Also, for an analysis of the courts' role in filling in the gaps in incomplete contracts, see Ayres and Gertner (1989).

174It is not suggested that the procedure, if adopted, should be mandatory. Anybody who wishes to deviate from it and design their own procedure should be allowed to do so.

175Note that ‘external’ considerations are excluded from the definition of efficiency; that is, it is assumed that the important benefits and costs have been incorporated into the valuation of the firm. For example, such items as the external benefit from maintaining employment in the local area are not included. If there are external considerations, government action may indeed be warranted, but bankruptcy law is the wrong instrument for dealing with such considerations. It would be better to have a general employment subsidy to save jobs rather than distort bankruptcy procedure in order to save bad firms.