A THEORY OF DEBT AND EQUITY - DIVERSITY OF SECURITIES AND MANAGER-SHAREHOLDER CONGRUENCE

This paper shows how the optimal financial structure of a firm complem ents incentive schemes to discipline managers, and how the securities' return streams determine the claim-holders' incentives to intervene i n management. The theory rationalizes (1) the multiplicity of securiti es, (2) the observed correlation between return streams and control ri ghts of securities, and (3) the partial congruence between managerial and equity-holder preferences over policy choices and monetary rewards as well as the low level of interference of equity in management. The theory also offers new prospects for a reappraisal of the earlier cor porate finance literature.