Property Rights, Risk and Leverage

Richard A. Graff and Joseph P. Kairys ()
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Richard A. Graff: Electrum Partners L.L.C., Postal: Chicago, IL
Joseph P. Kairys: Department of Economics, School of Economics and Commercial Law, Göteborg University, Postal: Box 640, SE 40530 GÖTEBORG

No 183, Working Papers in Economics from University of Gothenburg, Department of Economics

Abstract: Risk matters when corporate debt has a positive probability of default. Lenders have traditionally used covenants to protect their property rights because the financing and operating decisions of firms can reduce the value of the firm’s outstanding debt. We examine the use of captive finance subsidiaries and special purposed entities (SPEs) to partition default risk within the firm. A more complex arrangement of property rights within the firm allows the parent firm to retain operating flexibility while offering lenders better protection. We conclude that capital structure is a relevant decision variable for corporate managers because firms are able to obtain leveraged finance at a lower cost when risk is partitioned using separate legal structures within the firm.

Keywords: capital structure; captive finance companies; structured finance (search for similar items in EconPapers)
JEL-codes: D23 G32 (search for similar items in EconPapers)
Pages: 44 pages
Date: 2005-10-31
New Economics Papers: this item is included in nep-fin
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