Chapter

Capital Structure Decisions of a Public Company

Oliver Hart

in Firms, Contracts, and Financial Structure

Published in print October 1995 | ISBN: 9780198288817
Published online November 2003 | e-ISBN: 9780191596353 | DOI: http://dx.doi.org/10.1093/0198288816.003.0007

Series: Clarendon Lectures in Economics

 Capital Structure Decisions of a Public Company

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In a public company, ownership is dispersed among numerous small shareholders. In this context, day‐to‐day control is delegated to managers, and individual shareholders have little or no incentives to monitor management (the free‐rider problem). The chapter uses two simple models to illustrate the role of debt and seniority in constraining the behaviour of management when there is a separation between ownership and control. The basic idea is that debt is associated with a hard budget constraint, which can compel (self‐interested) managers to give up unprofitable but power enhancing decisions in order to avoid bankruptcy. The agency approach presented in this chapter is contrasted with the empirical evidence and other theories of capital structure.

Keywords: agency; budget constraint; capital structure; control; debt; free‐rider problem; ownership; seniority

Chapter.  13348 words.  Illustrated.

Subjects: Financial Markets

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