FIRM-SPECIFIC HUMAN-CAPITAL AND OPTIMAL CAPITAL STRUCTURE

We consider the moral hazard in managers undersupplying imperfectly-ma rketable firm-specific human capital. Firms may cope by granting long- term wage contracts that protect managers against employment terminati on. Although ex ante efficient, these contracts may be ex post ineffic ient when managerial ability is discovered to be low. Precommitted fir ms must honor these contracts, unless there is ownership transfer that permits their legal invalidation. Bankruptcy is one such transfer mec hanism. Since managers anticipate the contractual consequence of bankr uptcy, leverage worsens moral hazard; this cost provides a counterbala nce to the debt tax shield and leads to an optimal capital structure.