Debt, hedging, and human capital

Stephen D. Smith and Larry Wall

No 2005-30, FRB Atlanta Working Paper from Federal Reserve Bank of Atlanta

Abstract: This paper provides a theory of debt and hedging based on human capital. We distinguish human capital from physical capital in two ways: (1) human capital is inalienable and can exercise a one-sided option to leave the firm, and (2) human capital is not perfectly replaceable. We show that a firm may reach the first best solution while issuing debt or equity to outsiders provided that either the insiders receive a senior claim or that the firm hedges. We then show that, given asymmetric information concerning costs, the only viable solution has the firm issuing debt to outsiders and hedging.

Date: 2005
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Journal Article: Debt, hedging and human capital (2010)
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