BANKRUPTCY, WARRANTIES AND THE FIRMS CAPITAL STRUCTURE

This paper examines the role of capital structure as an instrument for shifting risk between real and financial markets. We consider a firm whose contractual agreements involve both consumers and debtholders and show that if consumers are risk averse, whereas equity and debtholders are risk neutral, the firm uses its capital structure to shift risk away from consumers. The optimal allocation of risk across real and financial markets leads the firm to be fully equity financed.