| There are three stages about economist's views of firm's financial structure decisions: First stage, given that firm value is constant, i.e. famous MM theorem. Second stage, to acknowledging that managerial actions affect profitability. Third stage, to recognizing that firm value depends on the allocation of decision or control rights. As if Hart(2001) pointed out, decision or control rights approach is very useful. Even though it is at an early stage of development, this approach has some empirical content: it can throw light on the structure of venture capital contracts and reasons for the diversity of claims. Thus, the study of financial contract theory based on control rights is very valuable.Actually, Financial contracting might be described as the theory of what kinds of deals are made between entrepreneur and investor. It focuses on two different kinds of issues: First, how to realize the following simple deal. Ordinarily, suppose an entrepreneur has a project but no money, and an investor has money but no project. There are gains from trade, but will they be realized? If the project gets off, how will it be financed? Second, how to explain trade in reality. We see companies around the world with a wide variety of financial structures. Almost all companies have owners (i.e. shareholders or equity holders). Some have other claimants, e.g., creditors, preferred shareholders, etc. why? Does this matter, for example, for corporate efficiency or investment behavior? What determines a company's debt-equity ratio, that is, the ratio of the market value of its debt to the market value of its equity?This questions like these have been the focus of much of the very large corporate finance literature that has developed over the last forty years, and they have also been studied in the more recent financial contracting literature. However, there are two very important limitations in the former two stage's theory: first, why does ownership and control rights separate; second, why use financial structure rather than an incentive scheme to solve what is really just a standard agency problem? Therefor, in the last twenty years or so, the financial contracting literature adds a new ingredient to the stew: decision (control) rights.Aghion-Bolton(1992) provides a simple direct explanation for the fact that ownership and control rights separate through introducing entrepreneur's wealth-constraint, and show that contingent control is an equilibrium control allocation in some circumstances, i.e., a so-called theory of optimal control rights arrangement. Aghion-Bolton model rightly analyses control rights arrangement in venture capital; while it doesn't do many public companies.In fact, the agency approach is a theory of optimal incentive schemes rather than capital structure; while the control rights model helps to explain the optimal allocation of control between insiders and outsiders, but not why, given a particular level of control by insiders, outsiders hold heterogeneous claims, i.e., some are shareholders while others are creditors.Dewatripont-Tirole (1994) and Hart(2001) think that the diversity of claim is good not because of the existence of collective action problems, but rather because diversity changes incentives. Consider that the intervention cost of outside investors is different, Hart induces the following result that the diversity of outside claims is an optimal financing mechanism; consider that investors have a different preference for ex post action, i.e., focusing on ex post efficiency, Dewatripont-Tirole induces a capital structure that equity and debt are coexistent.However, why are decision rights important in firm financing? As a matter of fact, it doesn't matter who makes decision in a comprehensive contract world, because an initial contract has already clearly specified how to deal with everything. So, none but incomplete contracting ideas can provide a natural way for the study of financial structure. In practice, recent most financial contract literature adopts the approach. Generally, given the particular form of incompleteness of contract, but they don't explain that the form is the result of optimal issue. After all, what result in incompleteness of contract? It is an important question that both property right theory and financial contract theory face with, i.e. foundation of incomplete contract.In addition, these theories have an issue of how to allocate cash flows. Aghion-Bolton model ignores entrepreneur's ex ante incentive. As a result, it isn't important that how to allocate cash flows. In evidence, this isn't reasonable, because firm's high profitability at least partially owes to entrepreneur's high effort. Hart's intervention cost model supposes that entrepreneur only is interested in private benefit but not in cash flows. Although this can simplify the issue that we analyse, this obviously is consistent with reality, because entrepreneur only cares about pecuniary returns, but can obtain a great lot of cash flows. Dewatripont and Tirole's equity and debt model mainly concentrates on the consideration of ex post incentive, but doesn't rightly deal with entrepreneur's ex ante incentive. Finally, these theories don't consider entrepreneur's financing cost and benefit in the different information structure. As a result, they can't give an answer that when entrepreneur is faced with different information structure how to make financing decision.This dissertation mainly concentrate on the above some critical issue and the limitation of existing financial contract theory. It consist of six chapter, the main content of every chapter as follow:Chapter 1: Introduction. First, this chapter briefly introduces the study of the former two stage; then, sums up the study progress of the third stage.Chapter 2: Control rights and foundation of incomplete contract. Even though control right approach already has been abroad adopted, and most scholar accepts the constraint that contract is incomplete, few people go behind the reason of incompleteness. This chapter detailedly summarizes the progress of foundation of incomplete contract, and gives some remarks. Chapter 3: Some shortcomings of firm financing theory. Based on ex ante incentive view of front chapter, the chapter pointes out some drawback of existing capital structure theory, and induces some study in the latter chapters.Chapter 4: Control allocation in firm financing and entrepreneur's incentive. Aghion- Bolton(1992) focuses on how the allocation of control rights affects the trade-off between cash flows and private benefits. They show that contingent control is an equilibrium control allocation in some circumstances. Fortunately, there is one striking finding of the Kaplan-Stromberg(2003): control rights and cash flow rights shift to the VC if the firm does poorly. Although this conclusion is consistent with the Aghion-Bolton model, it doesn't necessarily follow from it. Hart(2001) think that if we only consider ex post efficiency, we don't necessarily have such conclusion. Possibly the answer is that they ignore an important variable: effort. This chapter very good explains why control shifts to investor in bad state rather than good state through introducing entrepreneur's ex ante effort. Furthermore, it also finds out that the extent of financial constraint determines equilibrium control allocation of project.Chapter 5: The heterogeneity of risk preference and the diversity of financing. In contrast to Hart(2001) and Dewatripont-Tirole (1994), this chapter mainly focus on the following issue that the diversity can have a effect on entrepreneur's ex ante incentive rather than ex post incentive. We think that, when financial contract is incomplete and entrepreneur is wealth-constrained, residual control and seniority ordinarily should give to investors. This not only overcomes entrepreneur's ex post inefficiency, but also the most extent inspirit his ex ante effort, because residual control can restrict entrepreneur's ex post opportunism, and seniority can guarantee that entrepreneur's payoff and effort level of raising firm's profit is directly correlative. Consider that firm's profit is uncertain and investors have the difference of risk preference, different securities that entrepreneur issues can make firm's finance cost lower. In this way, diversity of outside claim makes investor's individual rationality constraint easily satisfied as well as entrepreneur's expected revenue maximal. Finally, the chapter shows that diversity of financing just is optimal finance mechanism.Chapter 6: Information cost and entrepreneur's financial decision. This chapter analyses incomplete financial contract between entrepreneur(insider) and investor(outsider) in the different information structure. It finds out, there are two ways of financing: non-market financing and market financing, its main cost separately are information rent that investor can extract and information disclosure cost that entrepreneur can spend; what's more, outside funds that project need and rate of return that capital market requires also are important determinant of entrepreneur's financial decision. In fact, if outside funds that project need is higher, information disclosure cost is lower, rate of return that capital market require is lower and information rent is higher, entrepreneur can more willingly choose market financing; otherwise, he can choose non-market financing. Again, existence of collusion and private benefit can influence entrepreneur's financial decision too.Chapter 7: Some facts that relate to previous theory. First, the chapter introduces real contract of venture capital, i.e., some particular contract provision and some useful way of reducing risk in venture capital. Then, offers some governance modes of public company in the whole world. To the extent, these facts provide real evidences for previous chapters'theory.This dissertation deep explores control rights arrangement and entrepreneur's financing decision in firm financing from first principles, and has a systematic study about various arrangement of financial contract and recent empirical findings. The dissertation has following main innovations in the studying:1. Consider that Aghion-Bolton model ignores an important variable: effort. This dissertation remedies this limitation of control right model through introducing entrepreneur's ex ante effort. As a result, it strictly shows equilibrium control allocation in different financial constraints, and obtains the ordering result of control rights arrangement.2. It reasonably explains why control rights, cash flows incentive and liquidation rights are all used simultaneously in real-world contracts. Moreover, based on the above innovation 1, it explains some useful ways of reducing investment risk.3. Dewatripont-Tirole (1994) and Hart(2001) mainly emphasize the ex post incentive role of capital structure, but ignore its ex ante incentive role. From the perspective of ex ante incentive, it carefully analyses all kinds of firm financing, then induces that the diversity is an optimal financing mechanism.4. The existing financial contract literature only analyses entrepreneur's financing decision in the given information structure, but not in the different information structure. The analysis of dissertation helps to understand why some firms willingly choose market financing but others not. |
