The Choice Between Bank Debt and Equity

Lars Jebjerg () and Søren Kyhl
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Søren Kyhl: Institute of Economics, University of Copenhagen

No 99-18, Discussion Papers from University of Copenhagen. Department of Economics

Abstract: : This paper develops a model of financing choice by an entrepreneur about to undertake a project. The entrepreneur is essential for the project but cash-constrained. Thus, he must sell part of the project to outside investors, while remaining in control as a manager. To finance the project he can sell shares to outside equityholders or approach a bank for a loan. The optimal financial structure trades-off an efficient project choice and efficient effort levels. Equity financing does not directly distort the project choice but has a distortionary effect on effort, which in turn may lead to an inefficient choice of project. Bank financing may lead to an inefficient project choice but creates only little effort distrotion for a given project. It is shown that the optimal financial structure varies with project characteristics and the external financing requirement.

Keywords: corporate finance; capital structure; banks (search for similar items in EconPapers)
JEL-codes: G21 G32 (search for similar items in EconPapers)
Date: 1999-07
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Persistent link: http://EconPapers.repec.org/RePEc:kud:kuiedp:9918

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