Research Details

Abstract

We develop a dynamic contracting theory of asset- and cash flow-based financing that demonstrates how firm, intermediary, and capital market characteristics 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). We implement the optimal contract between the firm and intermediary with both unsecured and secured debt (credit lines) in an overlapping pecking order: the firm simultaneously finances cash flow shortfalls with unsecured debt and either cash reserves (if available) or secured debt (otherwise). Improved access to equity financing increases debt capacity, thus debt and equity are dynamic complements. When the firm does well, it repays its debt in full, while when in distress, repayment dynamics mirror U.S. bankruptcy procedures.

Type

Working Paper

Author(s)

Konstantin Milbradt, Barney Hartman-Glaser, Simon Mayer

Date Published

2023

Citations

Milbradt, Konstantin, Barney Hartman-Glaser, and Simon Mayer. 2023. A theory of asset- and cash flow-based financing.