Publication Type

Working Paper

Publication Date

4-2017

Abstract

We explore the impact of strategic behaviour between three major stakeholders, namelyequity holders, debt holders, and a supplier of a critical input, on the choice of a firm’s capitalstructure and its organisational design, determining in-house production versus outsourcing theprocurement of the critical input. We show that an opportunistic coalition of the supplierand debt holders can trigger strategic bankruptcy even when the firm is solvent. Equity holdersrespond to this by either eliminating the supplier by producing the input in-house, or by reducingthe exposure to debt by funding the firm’s capital requirement through equity. Both responsescreate inefficiency since production of the input in-house is costlier and debt is cheaper thanequity. We show that the debt-equity ratio in equilibrium varies positively with (a) profitabilityof the cash flow and (b) marginal cost of the supplier’s input, but negatively with (c) riskinessof the cash flow and (d) equity holders’ costs of producing the input in-house.

Keywords

Incomplete Contracts, Opportunistic Behaviour, Bankruptcy, Capital Structure

Discipline

Finance | Growth and Development

Research Areas

Economic Theory

Creative Commons License

Creative Commons Attribution-Noncommercial-No Derivative Works 4.0 License
This work is licensed under a Creative Commons Attribution-Noncommercial-No Derivative Works 4.0 License.

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