Essays in Corporate Finance
I study the effect of human capital on firms' leverage decisions in a structural dynamic model. Firms produce using physical capital and labor. They pay a cost per employee they hire, thus investing in human capital. In default a portion of this human capital investment is lost. The loss of human capital constitutes a significant cost of financial distress. Labor intensive firms are more heavily exposed to this cost and respond by using less leverage. Thus the model predicts a decreasing relationship between leverage and labor intensity. Consistent with this prediction, I show in the data that high labor intensity leads to significantly less use of debt. In the model a move from the lowest to the highest decile of labor intensity is accompanied by a drop in leverage of 21 percentage points, very close to the 27 percentage point drop in the data. Overall, I argue that human capital has an important effect on firm leverage and should receive more attention from capital structure researchers.
Furthermore, I study a two-period contracting problem in which entrepreneurs need financing but have limited commitment. If an entrepreneur chooses to default, he can divert a proportion of the project's output. Entrepreneurs are heterogeneous with respect to their ability to divert output. In particular, I focus on the special case with only two types of entrepreneurs. "Opportunistic'' entrepreneurs can divert output, but "dependable'' entrepreneurs cannot. I find that, if the proportion of dependable entrepreneurs is sufficiently high, it is optimal to write contracts that induce second period default by the opportunistic entrepreneurs. This critical proportion generally decreases with the severity of the agency problem. The model delivers both cross-sectional and time-series predictions about default, investment, and output.
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