Debt, hedging, and human capital

Debt, hedging, and human capital

by Stephen D. Smith

Part of Working paper series / Federal Reserve Bank of Atlanta -- 2005-30

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"This paper provides a theory of debt and hedging based on human capital. We distinguish human capital from physical capital in two ways: (1) human capital is inalienable and can exercise a one-sided option to leave the firm, and (2) human capital is not perfectly replaceable. We show that a firm may reach the first best solution while issuing debt or equity to outsiders provided that either the insiders receive a senior claim or that the firm hedges. We then show that, given asymmetric information concerning costs, the only viable solution has the firm issuing debt to outsiders and hedging"--Federal Reserve Bank of Atlanta web site.

Discussion questions for Debt, hedging, and human capital

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  1. 1

    How does viewing employees as "human capital" rather than replaceable operational expenses change the way we think about corporate loyalty and organizational structure?

  2. 2

    In your own career, have you ever exercised that "one-sided option" to leave a firm, and how did the inalienability of your own skills influence that decision?

  3. 3

    The paper argues that human capital is fundamentally different from physical machinery because it cannot be easily replaced; how does this reality manifest in modern workplace dynamics and hiring crises?

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