Corporate Finance and Corporate Governance

TLDR

Debt and equity are viewed as alternative governance structures, with debt governed by rules and equity allowing greater discretion. The paper proposes a combined corporate finance and governance framework, arguing that asset characteristics determine whether debt or equity is preferable and contrasting transaction‑cost with agency theory. The authors adopt a project‑financing approach, illustrating their argument with examples from leasing and leveraged buyouts. Transaction‑cost reasoning shows that debt is preferable for redeployable assets, whereas equity is better for non‑redeployable assets.

Abstract

ABSTRACT A combined treatment of corporate finance and corporate governance is herein proposed. Debt and equity are treated not mainly as alternative financial instruments, but rather as alternative governance structures. Debt governance works mainly out of rules, while equity governance allows much greater discretion. A project‐financing approach is adopted. I argue that whether a project should be financed by debt or by equity depends principally on the characteristics of the assets. Transaction‐cost reasoning supports the use of debt (rules) to finance redeployable assets, while non‐redeployable assets are financed by equity (discretion). Experiences with leasing and leveraged buyouts are used to illustrate the argument. The article also compares and contrasts the transaction‐cost approach with the agency approach to the study of economic organization.