Capital Structure and Seniority in Entrepreneurial Firms

Filippo Ippolito

No 2005-FE-12, Economics Series Working Papers from University of Oxford, Department of Economics

Abstract: We present a model of cash constrained entrepreneurs who need an investor to finance their project. Investors can either be uninformed, such as individual bondholders, or informed, such as venture capitalists and banks. There is an entrepreneurial moral hazard problem, which can be partially overcome through monitoring only by informed investors. However, monitoring is only effective if investors can commit ex ante to liquidate the project after observing a poor signal. We show that a capital structure that minimizes commitment and information costs requires informed investors to hold senior convertible debt, uninformed investors to hold junior debt and entrepreneurs to hold common stock.

Keywords: Bank; Venture capital; Monitoring; Liquidation; Seniority; Convertible debt (search for similar items in EconPapers)
JEL-codes: G21 G24 G32 G33 (search for similar items in EconPapers)
Date: 2005-10-01
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