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Contract Costs and Financing Decisions

Eugene F. Fama
The Journal of Business
Vol. 63, No. 1, Part 2: A Conference in Honor of Merton H. Miller's Contributions to Finance and Economics (Jan., 1990), pp. S71-S91
Stable URL: http://www.jstor.org/stable/2353261
Page Count: 21
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Contract Costs and Financing Decisions
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Abstract

Like bondholders, most agents contract for fixed payoffs. Thus corporate capital structures, which are less than 50% debt, are less levered than overall contrast structures, in which about 90% of total flows are fixed payoffs. The hypothesis analyzed here is that loans and bonds lower contrast costs by delegating the monitoring and bonding of the default risks of fixed payoffs to credible specialists (financial intermediaries, bond-holder trustees, rating agencies, and auditors). Other agents can then focus on their specialities, that is efficient supply of labor, materials, and other services, and the contract problems of these specialties.

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