The Elgar Companion to Transaction Cost Economics
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The Elgar Companion to Transaction Cost Economics

Edited by Peter G. Klein and Michael E. Sykuta

Since its emergence in the 1970s, transaction cost economics (TCE) has become a leading approach in the research on contracts, firm organization and strategy, antitrust, marketing, inter-firm collaboration and entrepreneurship. With contributions by leading scholars in economics, law and business administration – including Oliver E. Williamson, recipient of the 2009 Nobel Prize in economics for his development of the transaction cost approach – this volume reviews the latest developments in TCE and applies them to contemporary theoretical and empirical problems.
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Chapter 24: Financial-Market Contracting

Dean V. Williamson


Dean V. Williamson Should a firm finance a project with non-recourse debt – that is, with debt that affords creditors recourse to nothing more than the project-specific assets in the event of default? Alternatively, should the firm finance a project with corporate-level debt – that is, with debt that affords creditors recourse to other assets in the firm? Should the firm even finance the project with infusions from equity investors? Finally, should the firm adopt a ‘financial structure’ that features a combination of debt and equity financing? These questions suggest that the firm might perceive tradeoffs in adopting one financial structure over another. While it may be easy enough to pose tradeoffs, characterizing optimal structures is a rich and interesting problem. To begin, the irrelevance theorems of Modigliani and Miller (1958) indicated that one can identify environments in which no particular structure dominates in equilibrium. The results motivated prodigious streams of research about how different structures can dominate, yet, forty years on Hart and Moore (1998, p. 1) could still observe that ‘economists do not yet have a fully satisfactory theory of debt finance (or of the differences between debt and equity)’. To fix ideas, consider the decision of one entity (the ‘firm’, say) to finance a discrete project with a financial contract called ‘debt’ by which the firm yields to another party (the ‘investor’) a non-contingent stream of payments and a right to foreclose – that is, with the right to march in and demand the redeployment of assets in the...

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