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Published in:
The Ownership of the Firm Read chapter Read first chapter

2015 | OriginalPaper | Chapter

6. Misinterpretations of Residual Claim in Finance and Corporate Law

Author : Kuo-Ping Chang

Published in: The Ownership of the Firm, Corporate Finance, and Derivatives

Publisher: Springer Singapore

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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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previous chapter Arbitrage and Valuation of Different Contracts
Footnotes
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.
 
Literature
Alchian A, Woodward S (1987) Reflections on the theory of the firm. J Inst Theor Econ 143:110–136
Fama E, Michael J (1983) Agency problems and residual claims. J Law Econ 26:327–349CrossRef
Grossman S, Hart O (1983) Unemployment with observable aggregate shocks. J Polit Econ 91:907–928CrossRef
Klein B, Crawford G, Alchian A (1978) Vertical integration, appropriable rents, and the competitive contracting process. J Law Econ 21:297–326CrossRef
Metadata
Title
Misinterpretations of Residual Claim in Finance and Corporate Law
Author
Kuo-Ping Chang
Copyright Year
2015
Publisher
Springer Singapore
Book
The Ownership of the Firm, Corporate Finance, and Derivatives

Print ISBN: 978-981-287-352-1

Electronic ISBN: 978-981-287-353-8

Copyright Year: 2015

DOI
https://doi.org/10.1007/978-981-287-353-8_6