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- Title
Optimal Entrepreneurial Financial Contracting.
- Authors
Ebrahim, M. Shahid; Mathur, Ike
- Abstract
The article presents a theory of optimal financial contracting by modeling the conflict of interest between risk averse entrepreneurs and financiers while incorporating deadweight costs such as bankruptcy and taxes. The general equilibrium framework is chosen over certainty equivalent models incorporating the capital asset pricing model because it avoids the assumption of a linear objective function. The authors remark that the results of their analysis are encouraging because they depict a unique interior solution for both risk-free and risky debt provided that the necessary conditions, which involve the distribution of net operating income, liquidating value of the project, the marginal rate of substitution and equilibrium interest rates, are satisfied. They conclude that risk-aversion results in a unique interior debt ratio for both the tax and no-tax situations. This result is contrary to the tax hypothesis of capital structure primarily due to linear models used by scholars, where the debt ratio is a corner solution.
- Subjects
CORPORATE finance; RISK management in business; BANKRUPTCY; CAPITAL assets pricing model; INTEREST rates; CAPITAL structure
- Publication
Journal of Business Finance & Accounting, 2000, Vol 27, Issue 9/10, p1349
- ISSN
0306-686X
- Publication type
Article
- DOI
10.1111/1468-5957.00360