Corporate financial structure, incentives and optimal contracting

Allen Franklin, Andrew Winton

Research output: Contribution to journalReview articlepeer-review

36 Scopus citations


The dominant paradigm in modern corporate finance views the firm as a nexus of contracts between various economic agents, particularly managers and investors. This chapter discusses optimal corporate financial structure within this basic framework. The observation is divided into two groups: those (security design) that derive optimal financial contracts as optimal mechanisms for overcoming various frictions between agents, and those (capital structure) that take certain contracts such as debt and equity as given and analyze the optimal mix of these contracts that firms should issue in the face of frictions between agents. Although the survey focuses on the design of optimal financial contracts, the distinction between the two groups is not always clear cut: some papers on security design make assumptions that immediately guarantee the use of specific contract types, while some papers on capital structure model the optimal choice of specific features of debt or equity securities.

Original languageEnglish (US)
Pages (from-to)693-720
Number of pages28
JournalHandbooks in Operations Research and Management Science
Issue numberC
StatePublished - Jan 1 1995
Externally publishedYes

Bibliographical note

Funding Information:
We thank an anonymous referee, Charles Calomiris, Darrell Duffle, Adam Dunsby, Gerald Garvey, Joseph Haubrich, Steven Huddart, Jeffrey Lacker, Vo-jislav Maksimovic, David Nachman, Thomas Noe, John Persons, Stephen Ross, and Yossi Spiegel for helpful comments. Franklin Allen gratefully acknowledges financial support from the National Science Foundation. Parts of this survey draw from Allen \[1990\]a nd Allen & Gale \[1994\].


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