OPTIMAL CAPITAL STRUCTURE IN AGENCY RELATIONSHIPS

We analyze the optimal design of capital structure in agency relationships. When a risk-averse principal controls the agent's capital structure, she awards a larger equity stake to outsiders the smaller the agent's productivity, When she controls both the timing and the terms of the agent's financing, the principal shifts to equityholders all risk associated with stochastic production and with the agent's unknown productivity. When the principal dictates only the terms of financing, only the former risk is borne by equityholders. When the principal is sufficiently averse to risk, she affords the agent no choice among incentive schemes.