Capital structure under costly enforcement

Hans K. Hvide, Tore Leite

Research output: Contribution to journalArticle


We consider financial structure and repayment behavior in a setting where cash flows are private information to the entrepreneur and the cost of enforcing repayment differs across security holders. If enforcement costs are lower for shareholders than for creditors, a mixed capital structure with debt and equity can obtain in equilibrium. Under a mixed capital structure, creditors intervene in low cash-flow states while shareholders intervene in high cash-flow states. Moreover, strategic defaults, costly bankruptcy, shareholder intervention, and violation of absolute priority occur with positive probability on the equilibrium path. Several of the predictions from our framework are consistent with evidence not readily explainable by existing theories.

Original languageEnglish
Pages (from-to)543-565
Number of pages23
JournalThe Scandinavian Journal of Economics
Issue number3
Early online date17 Sep 2008
Publication statusPublished - Sep 2008


  • absolute priority
  • cash diversion
  • costly state verification
  • financial contracts
  • outside equity
  • strategic defaults
  • debt contracts
  • state verification
  • renegotiation
  • equity
  • bankruptcy
  • reorganization
  • incentives
  • ownership
  • valuation


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