The Use of Debt and Equity in Optimal Financial Contracts

John H. Boyd, Bruce D. Smith

Research output: Contribution to journalArticle

11 Scopus citations

Abstract

We consider risk-neutral firms that must obtain external finance. They have access to two kinds of stochastic investment opportunities. For one, return realizations are costlessly observed by all agents. For the other, return realizations are costlessly observed only by the investing firm. We examine the optimal allocation of investment between the two projects and the optimal contract used to finance it. The optimal contractual outcome can be supported by appropriate (and determinate) quantities of debt and equity issues. Investments in projects with CSV problems are associated loosely with debt. Investments in projects with observable returns are associated with equity. Journal of Economic Literature Classification Numbers: G21, E51.

Original languageEnglish (US)
Pages (from-to)270-316
Number of pages47
JournalJournal of Financial Intermediation
Volume8
Issue number4
DOIs
StatePublished - Oct 1 1999

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