Specific Human Capital, Credible Commitment and Optimal Capital Structure

Xiaozu Wang

and

Tian Zhu

In this paper, we show that although ex ante equity holders would like to adopt an optimal displacement and operating policy, they may not have incentives to implement such a policy ex post when the manager acquires firm specific human capital and becomes indispensable to the firmís continued operation. An optimal mix of debt and equity can serve as a commitment device in disciplining the manager.

Key Words: Capital structure; Bankruptcy; Specific human capital; Credible commitment; Managerial incentive.
JEL Classification Numbers: G32, G33.