Abstract

Debts, Risk of Bankruptcy, Credit Contracts Market Value of Limited Companies

This paper is a contribution to the problem, which factors limit the proportion of debt that companies hold in their advantages of debt tend to be offset by anticipated (direct) bankruptcy costs. This opinion is critisized in this paper. First the tax advantage of debt is elaborated. Second the foundations of models explaining restrictions of the proportion of debt by anticipated (direct) bankruptcy costs are discussed. It is shown, that these models are not convincing. They give no convincing reason why bankruptcy should occur of all; bankruptcy costs are therefore introduced in an arbitrary manner. Third, it has to be explained how conflicts between share - and bondholders could be solved. An analysis reveals, that - given homogeneous expectations - direct bankruptcy costs are not very likely to occur: it is to be presumed that they do not offset the rather important tax advantages of debt. Fourth, it is elaborated that risky debt might be disadvantageous to bondholders and/or shareholders in four cases. These disadvantages could be avoided, if the time-state-dependent claims of creditors, who hold risky positions during the multi-period-history of the contract could be set up precisely. It is shown that the design of such contracts is desirable for bondholders and shareholders, because the positions of both could otherwise be expropriated. The results are important costs of design and control and disadvantages resulting from restrictions on managerial decisions. These costs have to be opposed to the tax advantages of debt.