Debt and Seniority: An Analysis of the Role of Hard Claims in Constraining Management

John Moore, Oliver Hart

Research output: Contribution to journalArticlepeer-review

Abstract

We argue that long-term debt has a role in controlling management's ability to finance future investments. Companies with high (widely held) debt will find it hard to raise capital, since new security-holders will have low priority relative to existing creditors; conversely for companies with low debt. We show that there is an optimal debt--equity ratio and mix of senior and junior debt if management undertakes unprofitable as well as profitable investments. We derive conditions under which equity and a single class of senior long-term debt work as well as more complex contracts for controlling investment behavior.
Original languageEnglish
Pages (from-to)567-589
Number of pages23
JournalAmerican Economic Review
Volume83
Issue number3
Publication statusPublished - Jun 1995

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