Abstract
The corporate finance literature claims that within a firm, debt is senior to equity (or debt has first claim over equity), e.g., “debt has prior claim on the firm’s assets and earnings, so the cost of debt is always less than the cost of equity” (Myers 2001, pp. 84–85). In this chapter, I will show that in the firm, though de jure (according to the corporate law) there might be first or residual claims, there is de facto no first claim between fixed-income assets and non-fixed-income assets. But the first claim among fixed-income assets can affect the market values of these assets.
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Notes
- 1.
E.g., Fama and Jensen (1983, p. 328) argue that “the residual risk—the risk of the difference between stochastic inflows of resources and promised payments to agents—is borne by those who contract for the rights to net cash flows. We call these agents the residual claimants or residual risk bearers”.
- 2.
See also the Robin Hood story in Chap. 1.
- 3.
Here it is assumed that the time-1 price of the mountain is at least $250, i.e., the debt is riskless. If the time-1 price of the mountain is less than $250, say, $180, then the equityholder will be given $180 to exchange for the stock which has zero value.
References
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Myers S (2001) Capital structure. J Econ Perspect 15:81–102
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Chang, KP. (2015). Misinterpretations of Residual Claim in Finance and Corporate Law. In: The Ownership of the Firm, Corporate Finance, and Derivatives. SpringerBriefs in Finance. Springer, Singapore. https://doi.org/10.1007/978-981-287-353-8_6
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DOI: https://doi.org/10.1007/978-981-287-353-8_6
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