A Backup Quarterback View of Mezzanine Finance

Abstract

Mezzanine nance is ubiquitous. Traditional arguments describe the purpose of Mezzanine debt as completing the market, specically as plugging a nancing gap. According to that view, intermediate seniority claims add to the available menu of risk-return combinations hence helps cater to the needs of heterogeneous investors and generates additional sources of capital for productive investment projects. We describe a completely dierent yet equally fundamental role for Mezzanine debt which creates economic value even in a world where all investors are homogenous and risk-neutral. According to our theory, Mezzanine nanciers serve as substitute managing agents back-up quarterbacks of sorts ready to replace the original borrower when the project underperforms.They enable senior borrowers to provide incentives to the original agent without resorting to inecient punishment such as foreclosing on the project even when its NPV as a going-concern remains positive. The fact that Mezzanine lenders tend to be industryspecialists while senior borrowers tend to be traditional intermediaries, we argue, constitutes direct evidence that Mezzanine stakeholders provide the expertise senior lending need to eciently mitigate agency frictions.