Sunk Investment, Bargaining and Choice of Capital Structure

Sudipto Dasgupta · Kunal Sengupta

156 citations0/0 files storedInternational Economic Review

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Abstract

This paper shows how a firm might optimally choose debt to affect the outcome of bilateral bargaining with workers or other input suppliers. It is shown that debt may alleviate the well-known underinvestment problem associated. with the inability to write precommitment contracts. Also, in such circumstances, debt could be Pareto improving over complete equity financing. The relationship between the optimal level of debt and asset specificity of investmen t and bargaining power of the firm vis-a-vis the workers is explored. The Williamson conjecture that higher asset specificity will lead to less debt is shown not to be valid in general. Copyright 1993 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

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References

1987The Economic Institutions of Capitalism 1958The Cost of Capital, Corporation Finance and the Theory of Investment 1982Perfect Equilibrium in a Bargaining Model 1986The Nash Bargaining Solution in Economic Modelling 1989Oligopoly and financial structure: the limited liability effect 1991A Theory of Debt Based on the Inalienability of Human Capital 1984Investment and Wages in the Absence of Binding Contracts: A Nash Bargaining Approach 1991The Threat of Unionization, the Use of Debt, and the Preservation of Shareholder Wealth

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