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- W1546904772 abstract "We explore the financing of a project when the agent can privately benefit by taking actions that reduce cash flows, and investors' only means of forcing repayment is the threat of termination. We introduce techniques to solve for the optimal contract (given the incentive constraints) in continuous time, and study the properties of the capital structure that implements the contract. The implementation involves a credit line, long-term debt and equity, as in a discrete-time model of DeMarzo and Fishman (2003). The continuous-time setting allows for a much cleaner characterization of the contract in terms of a differential equation, which we can then use to derive a number of new results. The optimal length of the credit line is determined by trade-off between the flexibility to run the project when it temporarily generates losses, and cost of delaying dividends until the credit line is paid off. Surprisingly, we find that the firm's total debt capacity is relatively insensitive to the project's volatility or the cost of liquidation. We derive explicitly how the optimal mix of long-term debt and credit varies with project characteristics. For example, the amount of long-term debt decreases with the project's volatility, the cost of liquidation, and the inefficiency of diversion. In some cases, the optimal long-term debt is negative; i.e., the firm holds a compensating cash balance while simultaneously borrowing (at a higher rate) through the credit line. We consider the implications of our model for security prices, and show that in many settings, the usual agency problems between debt and equity holders (asset substitution, strategic default) do not arise, and that optimal leverage declines with the firm's past profitability." @default.
- W1546904772 created "2016-06-24" @default.
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- W1546904772 date "2004-07-01" @default.
- W1546904772 modified "2023-09-26" @default.
- W1546904772 title "A Continuous-Time Agency Model of Optimal Contracting and Capital Structure" @default.
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- W1546904772 doi "https://doi.org/10.3386/w10615" @default.
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