NCJ Number
143589
Journal
Journal of Legal Studies Volume: 22 Issue: 1 Dated: (January 1993) Pages: 73-98
Date Published
1993
Length
26 pages
Annotation
This theoretical analysis of the role of debt and equity in the capital structure of business firms focuses on the roles of secured and unsecured debt and the reasons for the "ubiquity puzzle," which notes that secured credit apparently should be but is not ubiquitous.
Abstract
The analysis notes that secured debt serves as a management bond that limits the risk of a firm's project. In contrast, it appears puzzling that many firms pay for unsecured credit even though they could have pledged assets to obtain seemingly less costly secured credit. However, in public firms, unsecured credit can serve as a bond to equity against managers' self-interested and incompetent behavior. Management provides this bond when it has a firm issue unsecured debt as an invitation to public scrutiny by potential general creditors, who are not complacent in the way that secured creditors are. This scrutiny can reduce equity's agency costs. If this hypothesis is correct, no reason exists to question the current legal system's enforcement of secured contracts in bankruptcy situations. Further research will support or refute this hypothesis. Footnotes (Author summary modified)