Financial Slack Policy and the Laws of Secured Transactions

George G Triantis

The Journal of Legal Studies, 2000, vol. 29, issue 1, 35-69

Abstract: A manager's discretion depends on the firm's internal funds and its capacity to issue low-risk debt (together "financial slack"). The optimal amount of financial slack is a challenging problem in corporate finance. Too much slack encourages managerial misbehavior and exacerbates corporate agency problems. Too little slack prevents the firm from exploiting profitable investment opportunities. The various features of financial leverage including the amount of debt, maturity, covenants, default rights, and collateral may be used to regulate the degree of slack in a firm. This article demonstrates how the contours of priority rules and property rights associated with security interests in collateral and in proceeds contribute to optimal slack policy. The article contrasts the rule-based regime of U.C.C. Article 9 with the more flexible standards of the Bankruptcy Code. Copyright 2000 by the University of Chicago.

Date: 2000
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