Should You Take Out a Student Loan, Or Issue Equity?


Great post over at Cheep Talk about Kjerstin Erickson, who is selling a 6% stake in her lifetime income for $600,000.

Think of Kjerstin as a self-managed firm.  She could issue debt or equity.  The Modigliani-Miller theorem explains why most people in Kjerstin’s position choose to issue debt.  Her income is taxed, but interest on debt is often tax-deductible.

But a key difference between Kjerstin and a firm is that you if you acquire Kjerstin you cannot fire the manager.  So your capital structure is also your managerial incentive scheme.  Debt makes Kjerstin a risk-lover:  she gets all the upside after paying off her debts and her downside is limited because she can just default.  With equity she owns 94% of her earnings no matter what they are.

Why don’t Lawrence and other colleges and universities ask for an equity stake rather than providing student loans?  Evidently, economists from Milton Friedman to James Tobin have advocated such a system and it seems to work only too well.  Hence the beneficiaries opportunistically opting out of the deal.

Ah, well.