Waiting for Capital: Dynamic Intermediation in Illiquid Markets

When: 23 Nov 2021, 12:00-13:15
Where: Zoom
Speaker: Konstantin Milbradt

LawFin Research Seminar joint with Finance Seminar

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 950 9447 8343
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We consider a firm that has an internal carry cost of cash and infrequent access to public capital markets. In the interim, it contracts with a deep-pocketed but costly intermediary subject to limited commitment. Under the optimal financing agreement, the intermediary absorbs a fraction of cash-flow risk that decreases in the firm’s net-cash position. A credit-line with a state-dependent interest rate and early-repayment incentives, restricted equity that vests upon market access, and cash reserves jointly implement the optimal contract. Initially, the firm uses cash and the credit-line simultaneously. If the firm runs out of cash, it either liquidates or uses restricted-equity and the credit-line to sustain operations. Thus, an overlapping pecking order arises. Upon market access, the firm issues common equity to retire the credit line. Although the intermediary has deep pockets, it allows riskier firms to face endogenous liquidation. To ensure the survival of less risky firms, it acquires restricted-equity that it sells upon market access. The set of firms facing liquidation is smaller if market access, and therefore intermediary exit, is more likely. Importantly, the optimal financing agreement is renegotiation proof.