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Debt, bargaining, and credibility in firm-supplier relationships

Journal

Journal of Financial Economics

Subject

Finance

Authors / Editors

Hennessy C A;Livdan D

Publication Year

2009

Abstract

We examine optimal leverage for a downstream firm relying on implicit (self-enforcing) contracts with a supplier. Performing a leveraged recapitalization prior to bargaining increases the firm's share of total surplus. However, the resulting debt overhang limits the range of credible bonuses, resulting in low input quality. Optimal financial structure trades off bargaining benefits of debt with inefficiency resulting from overhang. Consistent with empirical evidence, the model predicts that leverage increases with supplier bargaining power (e.g., unionization rates) and decreases with utilization of non-verifiable inputs (e.g., human capital).

Keywords

Leverage; Debt overhang; Bargaining; Implicit contracts

Available on ECCH

No


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