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UBC Theses and Dissertations

Essays in corporate finance Colpitts, Jeffrey Charles


In the first essay, I consider the impact of tort liability on firms capital structure. Tort litigation is not only a substantial risk facing firms worldwide, but is also a unique form of risk, in that it can be exacerbated or mitigated by how firms adjust their debt-equity mix. I examine how firms ought to adjust their capital structure when faced with litigation, and consider various extensions to basic model. These include the interaction between capital structure, tort liability and insurance, how the problem changes when several firms face tort risk and are jointly and severally liable, and the implications that arise from moving from a one period to a two period setting. In the second essay, we develop and test a theory of insurers' choice of the mix of equity and liabilities. The role of equity in insurance markets and in our model is to back insurers' promises to pay claims when there is aggregate uncertainty, or dependence among risks. Depending on the nature of this aggregate uncertainty, the equity held by firms in a competitive insurance market may increase with rising uncertainty, or it may initially increase then decrease. The ratio of equity to revenue unambiguously increases with uncertainty. We test the model, as well as implications of recent models of insurance market dynamics, on a cross-section of U.S. property-liability insurers. In the third essay, I examine optimal contracting with risk averse managers. I start from the following observations: (1) managers select projects and exert effort; (2) risk averse managers make distorted project selection decisions, and this problem is increasing in risk aversion; (3) managers with low risk aversion are attracted to high-power compensation packages. I develop a model where high-power incentive contracts act as screening devices, helping firms attract less risk averse managers who will then make less distorted project selection decisions. Optimal contracts trade off the screening and effort-inducing benefits of incentive contracts against the deviation from optimal risk sharing. The resulting equilibrium provides a new perspective on why some managerial contracts feature such high-powered incentives, as well predictions for the cross-sectional variation in the power of incentive contracts.

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