Working Paper: NBER ID: w29712
Authors: Barney Hartman-Glaser; Simon Mayer; Konstantin Milbradt
Abstract: We develop a dynamic contracting theory of asset- and cash flow-based financing that demonstrates how firm, intermediary, and capital market characteristics jointly shape firms’ financing constraints. A firm with imperfect access to equity financing covers financing needs through costly sources: an intermediary and retained cash. The firm’s financing capacity is endogenously determined by either the liquidation value of assets (asset-based) or the intermediary’s going-concern valuation of the firm’s cash flows (cash flow-based). The optimal contract is implemented with defaultable debt — specifically unsecured credit lines and senior-secured debt — and features risk-sharing via bankruptcy. When the firm does well, it repays its debt in full. When it does poorly, distress resolution mirrors U.S. bankruptcy procedures (Chapter 7 and 11). Secured and unsecured debt are complements because risk-sharing via unsecured debt increases secured debt capacity. Debt and equity are dynamic complements because future access to equity financing increases current debt capacity.
Keywords: dynamic contracting; financing constraints; asset-based financing; cash flow-based financing
JEL Codes: D86; G32; G35
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| intermediary's valuation of cash flows (G19) | firm's financing capacity (G32) |
| liquidation value of assets (G33) | firm's financing capacity (G32) |
| improved access to equity financing (G24) | cash flow-based debt capacity (G32) |
| successful firm performance (L25) | full debt repayment (H63) |
| financial distress (G33) | bankruptcy dynamic (K35) |
| excess liquidity (E51) | firm's financing capacity (G32) |
| secured debt used when cash reserves are low (G21) | optimal financing contract (G32) |
| unsecured debt serves as a hedging mechanism across all states (H74) | optimal financing contract (G32) |