Structure of debt contracts with a weak moral hazard problem

• Autores: Cheol Park
• Localización: Journal of economic research, ISSN 1226-4261, Vol. 21, Nº. 3, 2016, págs. 357-386
• Idioma: inglés
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• Resumen

  • This paper presents a theory of debt structure when the moral hazard problem is not so severe. The resulting optimal contract consists of at least two different seniority classes of debt. The most senior debt contract must have a face value smaller than the interim liquidation value, and the face value of the junior claim should not exceed the debt capacity of the borrower. Being small relative to the liquidation value, senior lenders have an excessive incentive to liquidate the firm. This, combined with the limit placed on the gains from diluting junior claims, will effectively prevent the borrower from undertaking risky projects. We interpret our results as an explanation of commercial paper issues.