contracting with wealth constrained agents we examine how a project owner optimally selects a project operator and motivates him to deliver an essential noncontractible input e g effort when potential operators are privately informed about their limited wealth truthful revelation of wealth is induced by promising a higher probability of operation and if necessary a greater share of realized profit the larger the nonrefundable bond that a potential operator posts the project owner benefits when total wealth is widely dispersed among potential operators under plausible conditions limited knowledge of wealth is not constraining for the project owner

monitoring versus incentives abstract this paper analyzes the trade off between monitoring and incentives in a principal agent relationship with moral hazard we derive general results on the optimal monitoring incentives mix for the case where both parties are risk neutral and the agent faces a limited liability constraint we show that the principal uses less monitoring and stronger incentives if the agent s liability limit is relaxed or if monitoring costs increase to induce more effort on the part of the agent the principal resorts to more monitoring or to stronger incentives or both in particular there are cases where the cheapest way to induce more effort is to use lower powered money incentives but with much more precise monitoring

limited liability and incentive contracting with ex ante action choices abstract this article examines a principal agent model of financial contracting in which a risk neutral entrepreneur agent makes an unobservable ex ante effort choice while employing the investment funds of a risk neutral investor principal the key innovation is that the investment contract is subject to statutory liability limits given these liability limits two settings are considered one in which the investor payoff function is also constrained to be monotonically nondecreasing in firm profit and another in which no such monotonic contract constraint is imposed in the former case a standard debt contract is shown to emerge and a first best effort choice is not achieved in the latter setting the optimum is characterized by a live or die payoff function and a first best effort level may or may not be realized

can agents be better off with pay caps a popular way to discipline the managers of companies or banks that got into trouble during the recent financial crisis has been to impose caps on managers pay using a small extension of the standard principal agent model we argue that pay caps might serve the opposite purpose because the agent might be better off with a pay cap specifically we show that given a fixed effort level to be implemented the agent s expected utility can be decreasing in an upper bound for the agent s reward the effect of pay caps on the general structure of optimal incentive contracts is also characterized while an improvement of contracting information always helps the principal it might increase or decrease the marginal cost of imposing pay caps

market imperfections and crowdfunding this article is the first one that considers the choice between the different types of crowdfunding and traditional financing under different types of market imperfections in contrast to most existing literature we focus on financial aspects of crowdfunding rather than on price discrimination between customers using a new approach on the demand side the model provides several implications most of which have not yet been tested for example we find that when asymmetric information is important high quality projects prefer reward based crowdfunding a low quality firm may find it unprofitable to mimick this strategy as it will be taking more risk to achieve a threshold this result is contradictory to the spirit of the results in belleflamme et al journal of business venturing entrepreneurship entrepreneurial finance innovation and regional development 29 5 585 609 2014 which finds that asymmetric information favours equity based crowdfunding in contrast to belleflamme et al journal of business venturing entrepreneurship entrepreneurial finance innovation and regional development 29 5 585 609 2014 in our model crowdfunding does not have any ad hoc non monetary benefits

ex post participation constraint in a principal agent model with adverse selection and moral hazard abstract this paper analyzes optimal contracting when an agent has private information before contracting and exerts hidden effort that stochastically affects the output additionally the contract is constrained to satisfy the agent s ex post participation we highlight three features of this model first the agent faces countervailing incentives second the separation of types is never optimal third the optimal constant bonus rewarding success is distorted downward below its efficient level

strategic liquidity supply and security design we study how securities and issuance mechanisms can be designed to mitigate the adverse impact of market imperfections on liquidity in our model asset owners seek to obtain liquidity by selling claims contingent on privately observed future cash flows liquidity suppliers can be competitive or strategic in the optimal trading mechanism associated to an arbitrary given security issuers with low cash flows sell their entire holdings of the security while issuers with high cash flows are typically excluded from trade by designing the security optimally issuers can avoid exclusion altogether we show that the optimal security is debt because of its low informational sensitivity debt mitigates the adverse selection problem furthermore by pooling all issuers with high cash flows debt also reduces the ability of a monopolistic liquidity supplier to exclude them from trade in order to better extract rents from issuers with lower cash flows

the resolution of financial distress most models of financial structure embody an assumption about financial distress that causes debt to be costly to the issuing firm this approach has been criticized on the grounds that the assumed costs could be avoided by a costless financial reorganization in this article we show that despite the possibility of costless reorganization it may be rational for firms to incur significant costs in the resolution of financial distress the main assumptions that give rise to our results are the existence of asymmetric courts to impose a reorganization on the claimants of a firm article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

optimal vs traditional securities under moral hazard this paper provides an explanation for the widespread use of traditional securities by wellestablished firms standard moral hazard models predict that equity debt and warrants are almost never optimal financing instruments i show that issuing these securities is nevertheless nearly optimal the issuer would gain very little by using non traditional securities instead combined with equity one debt issue without multiple layers of seniority and one warrant issue without multiple exercise prices suffice to achieve near optimality the near optimality of traditional financing depends crucially on the issuer s ability to use war rants in addition to debt and equity

optimal incentive contracts under inequity aversion we analyze the classic moral hazard problem with the additional assumption that agents are inequity averse the presence of inequity aversion alters the structure of optimal contracts when the concern for equity becomes more important there is convergence towards linear sharing rules the sufficient statistics result is violated depending on the environment contracts may be either overdetermined i e include non informative performance measures or incomplete i e neglect informative performance measures finally our model delivers a simple rationale for team based incentives implying wage compression 2010 elsevier inc

pollution claim settlements reconsidered hidden information and bounded payments abstract a principal s production decision imposes a negative externality on an agent the principal may be a pollution generating firm the agent may be a nearby town the principal offers a contract to the agent who has the right to be free of pollution then the agent privately learns the disutility of pollution finally a production level and a transfer payment are implemented suppose there is an upper bound possibly zero on payments that the agent can make to the principal in the second best solution there is underproduction for low cost types while there is overproduction for high cost types in contrast to standard adverse selection models of pollution claim settlements there may thus be too much pollution compared to the first best solution

perquisites risk and capital structure in a corporate agency problem perquisites and risk interact to produce novel complex comparative statics for example even if additional debt induces risk neutral insiders to increase risk they never seek to increase the market value of their stock instead insiders decrease the present value of their subsequent conditionally optimal perquisites also the firm s optimal capital structure includes a risky bond with an agreement to remove insiders whenever the bond defaults however the optimal sharing rule between corporate claimants cannot be supported solely by standard securities such as bonds stocks options and their hybrids

executive effort and selection of risky projects this article examines the incentives of executives to adopt risky projects the agency problem considered is that of motivating the executive to expend effort to generate information about the profitability of projects and to select the best project conditional upon the information that his effort generates we show that the executive and the principal will not always agree regarding which project is best we provide conditions under which this conflict of interest leads from the principal s perspective to either an underinvestment or an overinvestment in risky projects

incentive schemes with multiple agents and bankruptcy constraints abstract we explore the effects of bankruptcy constraints on incentive schemes when two risk neutral agents operate in correlated environments our focus is on the subgame equilibrium in which each agent is induced via a direct mechanism to truthfully reveal his private information as a nash response to truth telling by his counterpart we identify a class of examples in which in contrast to the case where the agents are risk averse the nash constraints induce a subgame dominant strategy equilibrium thus implementation via direct mechanisms is feasible for this class more generally however the truth telling nash equilibrium may be subgame dominated so the question of implementation via direct mechanisms remains a delicate one

a multi period game theoretic model of venture capitalists and entrepreneurs abstract this study examines the relationship between a venture capitalist and an entrepreneur and follows it from its inception to the exit stage the model we use is a multi period game theoretic model with moral hazard where the contract is set in the first period the contribution of the study lies in the insights it provides on optimal contracts and its characterization of an endogenous exit point specifically the paper shows that the optimal incentive scheme should backload all incentive payments to the entrepreneur as much as possible consequently a straight debt contract would be optimal in venture financing

the financial crisis of 2008 in fixed income markets we explore how a relatively small amount of heterogeneous securities created turmoil in financial markets in much of the world in 2007 and 2008 the drivers of the financial turmoil and the financial crisis of 2008 were heterogeneous securities that were hard to value these securities created concerns about counterparty risk and ultimately created substantial uncertainty the problems spread in ways that were hard to see in advance the run on prime money market funds in september 2008 and the effects on commercial paper were an important aspect of the crisis itself and are discussed in some detail

imperfect information and the theory of government intervention in farm credit markets this paper describes some possible economic motivations for government intervention in farm credit markets these motivations are made possible by explicit departures from the perfect information and complete market assumptions that underlie both the neoclassical competitive paradigm and the fundamental theorems of welfare economics to be more precise the analysis focuses on three types of asymmetric information between farmers and prospective outside investors both of whom are assumed to be risk neutral arguably the three informational asymmetries examined here represent natural departures from perfect markets in that unlike the unencumbered neoclassical model each elicits farmers optimal use of debt contracts rather than equity instruments or other contractual forms to raise investment capital despite their consistency with observed contractual choices all three of the models analyzed below yield free market equilibria that diverge from first best perfect information outcomes given the inefficiency of these market equilibria the key question raised and discussed here is can government improve upon the derived competitive outcomes and if so how despite the enormity of the credit rationing literature only a few extant studies address this question in models that are consistent with debt contracts among them are demeza and webb 1987 1988 1989 and innes 1988 which focus on the third type of informational asymmetry considered below the other two information structures posited in this paper have been studied in several analyses of credit markets but with attention focused on positive attributes of the unfettered competitive equilibrium rather than on prospective implications for welfare enhancing government intervention in what follows th s literature is surveyed and for the first two information structures some new policy results a e presented a critical discussion of the paper s limitations concludes the article

push or pull performance pay incentives and information we study a principal agent model wherein the agent is better informed of the prospects of the project and the project requires both an observable and unobservable input we show 1 performance pay may not be optimal even if output is the only informative signal of an essential input 2 total surplus tends to be higher if one input is unobservable than if both inputs are observable and 3 bunching may arise amongst low and intermediate types we explore the implications for push and pull programs used to encourage r d activity but our results have applications beyond this context

anticompetitive financial contracting the design of financial claims this paper presents the first model where entry deterrence takes place through financial rather than product market channels in standard models of the interaction between product and financial markets a firm s use of financial instruments deters entry by affecting product market behavior whereas in our model entry deterrence occurs by affecting the credit market behavior of investors towards entrant firms we find that in order to deter entry the claims held on incumbent firms should be sufficiently risky i e equity in contrast to the standard branderlewis 1986 result that debt deters entry the model sheds light on the policy debate on the separation of banking as to whether banks should be permitted to hold equity in firms it also provides an explanation for why venture capitalists hold automatically convertible securities in start up firms

dosis facit effectum why the size of the carbon tax matters evidence from the swedish residential sector abstract after 25 years of gradually increasing its carbon tax sweden now imposes the world s highest tax on carbon dioxide emissions this paper examines the effect of the swedish carbon tax on residential carbon emissions by using european panel data we employ synthetic control methods scms and perform difference in difference did regressions to evaluate the causal impact of carbon taxation on carbon emissions in the residential sector we provide evidence that early 2000s carbon tax augmentation had a causal effect on residential carbon emissions we find that the reduction of residential carbon emissions stemming from the carbon tax augmentation ranges from 200 kg when compared with other countries with a carbon tax of more than 20 euro to 800 kg when compared with countries without a carbon tax of co2 per capita per year hence the evidence suggests that carbon taxation is an effective tool for reducing residential co2 emissions and in turn mitigating climate change

managerial compensation contract and bank bailout policy abstract under the incomplete contract framework we consider an optimal regulatory policy for motivating bank equity owners and bank managers to restructure the bad loans of their banks in the presence of managerial compensation contracts with stock options the regulatory policy studied in this paper is mainly concerned with the design of repayment schedules in the scheme of injection of cash funds into insolvent banks by the regulator we show that the regulator cannot necessarily attain the social optimal allocation by injecting cash funds into insolvent banks through the purchase of subordinated bonds with the risk free interest rate however even in that case we also suggest that if the regulator injects cash funds into active restructuring banks through the purchase of subordinated bonds or preferred stocks with less stringent repayment conditions and nationalizes passive restructuring banks the regulator can attain the social optimal allocation by performing such a non linear injection scheme under certain conditions

on the existence of share contracts under limited liability abstract in a principal agent relationship under limited liability the agent in general receives the full share of revenue we show that when the agent exerts effort in multiple tasks the effort substitution effect helps explain the existence of share contracts even under limited liability

relational incentive contracts standard incentive theory models provide a rich framework for studying informational problems but assume that contracts can be perfectly enforced this paper studies the design of self enforced relational contracts i show that optimal contracts often can take a simple stationary form but that self enforcement restricts promised compensation and affects incentive provision with hidden information it may be optimal for an agent to supply the same inefficient effort regardless of cost conditions with moral hazard optimal contracts involve just two levels of compensation this is true even if performance measures are subjective in which case optimal contracts terminate following poor performance jel c73 d82 l14

dynamic security design convergence to continuous time and asset pricing implications an entrepreneur with limited liability needs to finance an infinite horizon investment project an agency problem arises because she can divert operating cash flows before reporting them to the financiers we first study the optimal contract in discrete time this contract can be implemented by cash reserves debt and equity the latter is split between the financiers and the entrepreneur and pays dividends when retained earnings reach a threshold to provide appropriate incentives to the entrepreneur the firm is downsized when it runs short of cash we then study the continuous time limit of the model we prove the convergence of the discrete time value functions and optimal contracts our analysis yields rich implications for the dynamics of security prices stock prices follow a diusion reflected at the dividend barrier and absorbed at zero their volatility as well as the leverage ratio of the firm increase after bad performance stock prices and book tomarket ratios are in a non monotonic relationship a more severe agency problem entails lower price earning ratios and firm liquidity and higher default risk

robustness of simple menus of contracts in cost based procurement abstract we consider a model of cost based procurement in which the principal faces knightian uncertainty about the agent s preferences for cost reduction we show that a particularly simple incentive scheme a menu comprising a fixed price contract and a cost reimbursement contract minimizes the maximum expected payment where this maximum is taken over the set of possible agent preferences for some parameters of the problem a range of alternative incentive schemes also satisfy this criterion we show that the simple incentive scheme is not weakly dominated by any of the alternatives there does not exist an alternative mechanism for which the expected payment is no higher for all realizations of the agent s preferences and strictly lower for some realization

the debt hangover renegotiation with noncontractible investment abstract this paper analyses the incentives of the equityholders of a levered company to undertake noncontractible investments this noncontrability is shown to seriously impede the efficiency of any renegotiation process in the debt overhang problems conditions for obtaining a fully efficient level of investment choice are derived

should banks own equity stakes in their borrowers a contractual solution to hold up problems abstract this paper develops a model to answer the question whether a bank should hold a share of the equity of a borrowing firm the model shows that a small equity stake held by the bank can have a significant and positive impact on the lending relationship the benefit of bank equity participation arises from the reduced ability of the bank to extract rents from the firm in multiple rounds of financing this in turn improves the firm s incentive to make investments in profitable projects that require future outside finance the benefit is likely to be significant for small to medium size firms growth firms and firms with ongoing capital needs the paper addresses from a corporate finance perspective the current debate about whether banks should be allowed to own equity stakes in corporations and how large these equity stakes should be

implementing high powered contracts to motivate intertemporal effort supply we characterize the optimal contract between a principal and a risk neutral wealth constrained agent when an adverse selection problem follows a moral hazard problem the optimal contract in this setting often is more steeply sloped for the largest output levels than is the optimal contract in either the standard moral hazard setting or the standard adverse selection setting the large incremental rewards for exceptional performance motivate the agent to deliver substantial effort both before and after he acquires privileged information about the production environment

moral hazard and the property rights approach to the theory of the firm abstract in the grossman hart moore property rights theory there are no frictions ex post i e after non contractible investments have been sunk in contrast in transaction cost economics ex post frictions play a central role we bring the property rights theory closer to transaction cost economics by allowing for ex post moral hazard as a consequence central conclusions of the grossman hart moore theory may be overturned in particular even though only party a has to make an investment decision b ownership can yield higher investment incentives moreover ownership matters even when investments are fully relationship specific i e when they have no impact on the parties disagreement payoffs

in defense of usury laws usury law is often criticized by economists for curtailing lending and thus creating deadweight costs this paper shows that if moral hazard leads to credit rationing a just binding usury law creates a deadweight gain this property also holds in most market clearing equilibria independent of social insurance benefits or curbing present biased preferences interest rate caps have merit

justifying the first order approach to principal agent problems it is of interest to know when the incentive compatibility conditio n in principal agent problems can be replaced by the condition that the agent s expected utility be stationary in effort the mirrlees rogerson conditions do not work if the principal can observe more than one observable statistic also the mirrlees rogerson assumption that the distribution function of output is convex in the agent s action is unsatisfactory even in the context of the basi c model it is too restrictive the paper presents a suite of conditio ns that are applicable to the multistatistic case and replaces the objectionable convex distribution function assumption copyright 1988 by the econometric society

corporate fraud and investment distortions in efficient capital markets inefficient investment allocation induced by corporate fraud where informed insiders strategically manipulate outside investors beliefs has been endemic historically and has recently attracted much attention we reconcile corporate fraud and investment distortions with efficient capital markets building on shareholder manager agency conflicts and investment renegotiation in active takeover markets because investments that are ex post inefficient are not renegotiation proof the optimal renegotiation proof contract induces overstatements by managers accompanied by overinvestment in low return states and underinvestment in high return states by rational investors our framework also helps explain why easy access to external capital appears to facilitate corporate fraud

costly state verification with varying risk preferences and liability abstract in the scenario of loan contracts with costly state verification we examine how the properties of the set of states different risk preferences of debtors and varying liability of lenders affect the structure of optimal repayments in particular we show that with risk averse debtors a general set of states a constant observation cost and both unlimited and limited lender liability the debtor is strictly better off revealing the true state of nature when his realized revenue is low which implies that optimal debtor consumption has a downward jump around the single switch from observed to unobserved states if the debtor can destroy revenue or if the debtor is risk neutral this non monotonicity of consumption disappears moreover given the loan size there is more monitoring under debtor risk aversion than risk neutrality we present simulations showing that a contract with unlimited lender liability and debtor risk aversion has a higher expected observation cost but a lower variance of consumption than a contract with limited lender liability finally we discuss the problems of commitment to verification and contract renegotiation in this framework

hardball and the soft touch the economics of optimal insurance contracts with costly state verification and endogenous monitoring costs abstract we examine an environment of costly state verification in which insureds possess private information about the magnitude of an insurable loss insurers can verify the actual loss suffered only by incurring a positive resource cost and insureds may verification and may lead to more generous settlements optimal insurance contracts are shown to mitigate the incentives to evade by a combination of incentives which include the overpayment of easily monitored losses and undercompensation for claims exhibiting higher verification costs

short selling and price discovery in corporate bonds we show short selling in corporate bonds forecasts future bond returns short selling predicts bond returns where private information is more likely in high yield bonds particularly after lehman brothers collapse of 2008 short selling predicts returns following both high and low past bond returns this together with short selling increasing following past buying order imbalances suggests short sellers trade against price pressures as well as trade on information short selling predicts bond returns both in the individual bonds that are shorted and in other bonds by the same issuer past stock returns and short selling in stocks predict bond returns but do not eliminate bond short selling predicting bond returns bond short selling does not predict the issuer s stock returns these results show bond short sellers contribute to efficient bond prices and that short sellers information flows from stocks to bonds but not from bonds to stocks

informed lending and security design we examine the role of security design when lenders make inefficient accept or reject decisions after screening projects lenders may be either too conservative in which case they reject positive npv projects or too aggressive in which case they accept negative npv projects in the first case the uniquely optimal security is debt in the second case it is levered equity in equilibrium profitable projects that are relatively likely to break even are financed with debt while less profitable projects are financed with equity highly profitable projects are financed by uninformed arm slength lenders professional lenders have specialized expertise in screening projects unlike the typical entrepreneur to whom they lend they have been exposed to a wide variety of projects in the past professional lenders have experienced loan officers and analysts who know precisely what information is relevant how to treat soft information such as management quality and how to weigh the various pieces of information in making a forecast of the project s cash flows and default risk this paper examines how securities should be optimally designed when lenders make inefficient accept or reject decisions after screening projects in our model screening generates an informative albeit private signal about the project s profitability high signals indicate a positive net present value npv and low signals indicate a negative npv where the project s npv is increasing

limited liability contracts between principal and agent abstract the optimal strategy of the principal is examined in an environment where there are ex post limitations on the maximum penalty that can be imposed on a riskneutral agent contrary to the case in which such limitations are not imposed it is in the principal s interest to deliberately forego the opportunity to induce socially efficient behavior and to instead design a contract that induces the agent to realize an efficient outcome only in the most productive state of nature and perhaps in certain very unproductive states the properties of the contract are examined in detail

too much investment a problem of asymmetric information this paper shows that under plausible assumptions the inability of lenders to discover all of the relevant characteristics of borrowers results in investment in excess of the socially efficient level raising the rate of interest above the free market level will restore optimality this conflicts with generally held views and is contrasted with the stiglitz weiss model it is shown that the assumptions which yield overinvestment support debt as the equilibrium method of finance however under the stiglitz weiss assumptions used to derive an underinvestment result equity is shown to be the equilibrium method of finance

minimum payments and induced effort in moral hazard problems abstract consider a moral hazard problem in which there is a constraint to pay the agent no less than some amount m this paper studies the effect of changes in m on the effort that the principal chooses to induce from the agent we present sufficient conditions on the informativeness of the signal observed by the principal and on the agent s utility under which when m increases induced effort and hence productivity falls we also study how the cost minimizing contract for any given effort level varies in m we present an efficient algorithm for numerically calculating optimal contracts for given parameters and show that induced effort falls when m is increased in many cases even when our sufficient conditions fail

job design with sequential tasks and outcome externalities revisited we revisit job design with sequential tasks and outcome externalities from a different perspective extending schmitz 2013a when two sequential tasks need to be performed by wealth constrained agents the principal can hire only one agent or two different agents when there exists an outcome externality in terms of the fixed cost and such an externality is not too large if the two tasks are conflicting resp synergistic then it is optimal for the principal to hire two different agents resp only one agent when there exists an outcome externality regarding the marginal cost the opposite result holds

costly monitoring loan contracts and equilibrium credit rationing this paper develops a model with asymmetrically informed agents and costly monitoring of loan contracts where an equilibrium can exhibit credit rationing borrowers are identical ex ante but some receive loans and others do not in contrast to existing credit rationing theories rationing does not occur here due to inflexible prices adverse selection or moral hazard optimizing behaviour produces a standard debt contract in equilibrium the aggregate quantity of loans and equilibrium interest rates respond differently depending on whether there is rationing in equilibrium

contract choice in agriculture with joint moral hazard in effort and risk we analyze optimal contract choice in agriculture when there is joint moral hazard on the part of the farmer in the supply of effort and the riskiness of the technique of cultivation in the presence of limited liability high powered incentive contracts such as fixed rental contracts will induce the farmer to adopt techniques of cultivation that are too risky from the point of view of the landlord on the other hand low powered incentive contracts such as fixed wage contracts will induce the farmer to supply too little effort we show that sharecropping contracts emerge as a natural solution to balance these two conflicting considerations

fund families as delegated monitors of money managers because a money manager learns more about her skill from her management experience than outsiders can learn from her realized returns she expects inefficiency in future contracts that condition exclusively on realized returns a fund family that learns what the manager learns can reduce this inefficiency cost if the family is large enough the family s incentive is to retain any given manager regardless of her skill but when the family has enough managers it adds value by boosting the credibility of its retentions through the firing of others as the number of managers grows the efficiency loss goes to zero

limited liability and incentive contracting with multiple projects i examine a principal agent model with multiple projects where a risk neutral manager is protected by limited liability the analysis has several interesting implications i incentive problems are shown to be a natural source of economies of scope as combining multiple projects under the management of a single manager relaxes the limited liability constraint ii as a result managers may be overloaded with work and exert inefficiently high effort and iii the analysis has implications for the optimal allocation of projects to different managers copyright 2001 by the rand corporation

performance incentives with award constraints this paper studies the provision of incentives in a large u s training organization which is divided in about 50 independent pools of training agencies the number and the size of the agencies within each pool vary greatly each pool distributes performance incentive awards to the training agencies it supervises subject to two constraints the awards cannot be negative and the sum of the awards cannot exceed an award budget we characterize the optimal award function and derive simple predictions about how award prizes should depend on the number of agencies on their sizes and on their performances our results indicate that the constraints on the award distribution bind and reduce the overall e ciency of the incentive system jel h72 j33 l14

moral hazard and adverse selection the question of financial structure this paper looks at the moral hazard and adverse selection problems confronting an entrepreneur offering securities to an uninformed but competitive financial market the adverse selection aspect of the problem is generated by the unobservable entrepreneur s ability to transform effort into value moral hazard arises because the investment decision is made subsequent to financing we consider the joint use of both debt and equity and characterize the equilibrium relation between capital structure and unobservable attributes it is shown that 1 investment and financing are not separable 2 there is an underinvestment problem for better firms and 3 simultaneous use of both debt and equity can resolve this difficulty we also establish a connection between expected terminal firm value and debt promised payment level and between share retention and standard deviation agency problems in corporate finance originated with the influential papers of jensen and meckling 11 myers 17 ross 21 and leland pyle 14 they show that the market imperfections induced by unobservable actions lack of contracting ability and information asymmetry generally lead to second best outcomes in which the distribution of corporate ownership is achieved only at significant cost these costs take the form of excessive perquisite consumption overinvestment underinvestment and incomplete diversification of personal investment portfolios moral hazard and adverse selection comprise two forms in which agency problems may take shape arrow 1 equates these two terms with hidden action and hidden information respectively moral hazard arises when the action undertaken by the agent is unobservable and has a differential value to the agent as compared to the principal adverse selection problems arise when the agent has more information than the principal the resolution of such difficulties has been explored in a number of contexts with both signals and contingent contracting mechanisms these definitions exclude certain agency problems in the delegation literature for which the preference incongruity results from a lack of precommitment rather than some exogenous feature of the model in corporate finance one would thus identify the jensen meckling paper with moral hazard because perquisites enter the insider s objective differently from outsiders while darrough is from columbia university and stoughton is from the university of california irvine the second author s research was partially supported by grant number 410 83 0786 r 1 from the social sciences and humanities research council of canada this paper was presented at the 1984 meetings of the western finance association in vancouver and at the 1985 european finance association meetings in bern we thank kose john and frans tempelaar for their comments at the meetings

optimal incentives and securitization of defaultable assets abstract we study optimal securitization in the presence of an initial moral hazard a financial intermediary creates and then sells to outside investors defaultable assets whose default risk is determined by the unobservable costly effort exerted by the intermediary we calculate the optimal contract for any given effort level and show the natural emergence of extreme punishment for defaults under which investors stop paying the intermediary after the first default with securitization contracts optimally designed we find securitization improves the intermediary s screening incentives furthermore the equilibrium effort level and the surplus converge to their first best levels with sufficiently many assets

dynamic microlending under adverse selection can it rival group lending we derive an optimal lending contract in a two period adverse selection model with limited commitment on the borrower side the contract involves penalty interest rates after default and favorable rates after success under some conditions it also charges first time borrowers higher rates than repeat borrowers as in relationship lending because the lender is constrained to keep borrowing attractive while using revealed information to price for risk we compare the efficiency of a group lending contract of the kind popularized by the microcredit movement to the dynamic individual contract both types of contracts reveal the same information but the contracts face different constraints on using the information to improve risk pricing as a result either type of contract can lead to greater efficiency depending on specifics of the environment opening the possibility that dynamic lending has played a role comparable to that of group lending in the success of microcredit we also characterize the optimal dynamic group contract when both lending techniques are feasible and find that it combines both approaches but with varying emphases a recurrent theme is that in more marginal environments dynamic lending performs relatively better than and is prioritized over group lending we also discuss a number of extensions including spatially and serially correlated risk and the effect of competition

firm specific human capital amd optimal capital structure the authors consider the moral hazard in managers undersupplying imperfectly marketable firm specific human capital firms may cope by granting long term wage contracts that protect managers against employment termination although ex ante efficient these contracts may be ex post inefficient when managerial ability is discovered to be low precommitted firms must honor these contracts unless there is ownership transfer that permits their legal invalidation bankruptcy is one such transfer mechanism since managers anticipate the contractual consequence of bankruptcy leverage worsens moral hazard this cost provides a counterbalance to the debt tax shield and leads to an optimal capital structure copyright 1994 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

producer protection legislation and termination damages in the presence of contracting frictions this study models producer protection legislation ppl that would grant growers the right to claim damages if their contracts are prematurely terminated in the absence of contracting frictions that prevent contractors from redesigning contracts to accommodate exogenous policy changes producer protection legislation damages ppld would not be distortionary or redistributive if contracting frictions exist then ppld would have efficiency and redistributive effects though the direction and magnitude depends on the size of ppl damages vis a vis expected damages under existing contract law this study clarifies the conditions under which ppld would decrease efficiency and protect growers

adverse selection and convertible bonds informational asymmetries between a firm and investors may lead to adverse selection in capital markets this paper demonstrates that when the market obtains noisy information about a firm over time this adverse selection problem can be costlessly solved by issuing callable convertible bonds with restrictive call provisions such securities can be designed to make the payoff to new claimholders independent of the private information of the manager this eliminates the possibility of any dilution of equity or underinvestment and implements the symmetric information outcome in either a pooling or a separating equilibrium the same first best efficient outcome can also be implemented by issuing floating price and mandatory convertibles

theory and evidence on the resolution of financial distress we analyze a financially distressed owner managed project the main results of the model are 1 borrower default is an endogenous response to the anticipated restructuring foreclosure outcome 2 the lender s restructuring foreclosure decision depends critically on the interaction between project value and industry liquidity and 3 the lender waits for the industry to recapitalize before selling assets obtained through foreclosure empirical analysis of a large sample of defaulted commercial real estate loans supports many of the model predictions including restructuring foreclosure outcomes that are consistent with endogenous borrower default and firesale discounts that vary depending on industry market conditions at the time of foreclosure jel g33 copyright 2006 oxford university press

optimal leverage and aggregate investment we analyze the optimal financing of investment projects when managers must exert unobservable effort and can also switch to less profitable riskier ventures optimal financial contracts can be implemented by a combination of debt and equity when the risk shifting problem is the most severe while stock options are also needed when the effort problem is the most severe worsening of the moral hazard problems leads to decreases in investment and output at the macroeconomic level moreover aggregate leverage decreases with the risk shifting problem and increases with the effort problem

corporate financing an artificial agent based analysis we examine corporate security choice by simulating an economy populated by adaptive agents who learn about the structure of security returns and prices through experience through a process of evolutionary selection each agent gravitates toward strategies that generate the highest payoffs despite the fact that markets are perfect and agents maximize value a financing hierarchy emerges in which straight debt dominates other financing choices equity and convertible debt display significant underpricing in general the smaller the probability of loss to outside investors the more likely the firm is to issue the security and the smaller the security s underpricing

what can we learn from simulating a standard agency model abstract for typical parametrizations of the standard bell journal of economics 10 1979 74 agency model this paper demonstrates that the set of first order conditions characterizing the optimal contract can be reduced to a single equation a problem of investment financing under moral hazard is used to illustrate the reduced form equation s usefulness in quantitative applications when the agent has cara preferences over consumption it is shown that any exogenous limit on the penalties for low output is always binding

the macroeconomics of shadow banking we propose a dynamic macroeconomic model of nancial intermediation in an environment where households demand liquid assets in contrast to the literature intermediaries can issue equity without any friction in normal times intermediaries maximize liquidity creation by levering up the collateral value of their assets a process we call shadow banking a rise in uncertainty causes investors to demand liquidity in bad states intermediaries respond by simultaneously deleveraging and substituting toward safe liabilities shadow banking eectively shuts down prices fall and investment plummets the model generates amplication via endogenous collateral runs as well as ight to quality eects the model s macroeconomic eects are consistent with a slow economic recovery even when and especially when intermediary capital is high we analyze the impact of several policy interventions in the areas of unconventional monetary policy and regulatory reform

job design with conflicting tasks reconsidered a principal wants two sequential tasks to be performed by wealth constrained agents suppose that there is an outcome externality i e a first stage success can make second stage effort more or less effective if the tasks are conflicting the principal s profit maximizing way to induce high efforts is to hire one agent to perform both tasks so that the prospect to get a larger second stage rent after a first stage success motivates the agent to work hard in the first stage in contrast when there is an effort externality i e first stage effort reduces or increases the probability of a second stage success then the principal prefers to hire two agents whenever the tasks are conflicting

public trading and private incentives this article studies the link between public trading and the activity of a firm s large shareholder who can affect firm value public trading results in the formation of a stock price that is informative about the large shareholder s activity this increases the latter s incentives to engage in value increasing activities indeed if he has to liquidate part of his stake before the effect of his activity is publicly observed a more informative price rewards him for his activity implications are derived for the decision to go public capital structure and security design we consider a firm with a large shareholder and otherwise dispersed shares which are publicly traded the block holder is an insider in the sense that he can undertake actions that directly affect the firm s value moreover the insider might not take all value increasing actions as at least some of them involve a private cost for him in other words there is an incentive problem the article s main premise is that public trading as part of the price formation process generates information not only about exogenous factors affecting firm value but also about the insider s activity for instance as a result of public trading a firm s stock price will incorporate the market s evaluation of how a controlling shareholder allocates corporate resources we identify two sources of incentives for the insider to engage in activities that will increase firm value the first one is his stake in the firm since the insider participates in a value increase in proportion to his equity stake a larger stake increases the benefit to him from the firm value being high the view that large shareholders affect firm value is indeed widespread shleifer and vishny 1997 they alleviate the free rider problem pervasive in firms with passive dispersed investors unable or unwilling to affect the firm s operations that is outsiders

an analysis of the principal agent problem most analyses of the principal agent problem assume that the principal chooses an incentive scheme to maximize expected utility subject to the agent s utility being at a stationary point an important paper of mirrlees has shown that this approach is generally invalid we present an alternative procedure if the agent s preferences over income lotteries are independent of action we show that the optimal way of implementing an action by the agent can be found by solving a convex programming problem we use this to characterize the optimal incentive scheme and to analyze the determinants of the seriousness of an incentive problem

structuring international cooperative ventures we examine the effect of bargaining power and informational asymmetry on the design of international cooperative ventures in the presence of restrictions on equity participation and investment when the bargaining advantage rests with the multinational equity participation restrictions can increase the profits to domestic firms and encourage sub optimal investment policies overinvestment occurs when the multinational s bargaining advantage is reinforced by an informational advantage while underinvestment occurs when the domestic firm possesses the informational advantage in contrast when the bargaining advantage rests with the domestic firm equity participation restrictions do not affect investment levels

trade tragedy and the commons we develop a theory of resource management where the degree to which coun tries escape the tragedy of the commons and hence the de facto property rights regime is endogenously determined three forces determine success or failure in resource management the regulator s enforcement power the extent of har vesting capacity and the ability of the resource to generate competitive returns without being extinguished the model can explain heterogeneity across coun tries and resources in the effectiveness of resource management and it predicts that changes in prices population and technology can cause transitions to better or worse management regimes jel p14 q21 q22 q23 q32 many of the world s major renewable resource stocks are in a state of decline this is true for capture fisheries for forests in developing countries and for many measures of the biosphere s health other renewable resources including many species of wildlife marine mammals and coral reefs are also under threat while poverty and government corruption are surely respon sible for some of this record particular emphasis is often placed on the potentially damaging role played by international trade this emphasis is not surprising given that natural resource products are a key export for much of the developing world and property rights over renewable resources are both difficult to define and poorly enforced but property rights are not an immutable country characteristic such as weather mineral deposits or topography they are instead market institutions developed to facilitate transactions and protect scarce resources consequently changes in prices technology and other effects of market integration may alter the de facto property rights regime and lead to impacts quite dif ferent from those predicted by existing analyses the purpose of this paper is to examine renew able resource use within a framework where the enforcement of property rights and hence the efficacy of resource management is endogenously determined we develop a theory where an existing government regulates the use of a renewable resource by a set of agents who have a right to harvest the resource could be a fishery forest stock aquifer etc and we assume it is local and therefore contained within one country the govern ment sets rules limiting harvests but agents may cheat on these allocations and risk punishment property rights are endogenous in this framework because the government must account for agents incentive to cheat as a result the effective protection for the resource or what we refer to as the de facto property rights regime may be far from perfect even though property rights would be perfectly enforced if there was no monitoring problem

optimality of debt under flexible information acquisition we study the optimality of debt through the interaction between se curity design and information acquisition an impatient seller designs an asset backed security and a buyer decides whether to buy it to provide liquidity facing dierent securities the buyer has incentives to acquire in formation from dierent aspects of the fundamental which in turn aects security design speci cally the buyer bene ts from information acqui sition at the expense of the seller through adverse selection the seller hence deliberately designs the security to induce the buyer to acquire the information least harmful to the seller s interest since securities can be designed in arbitrary ways the resulting incentive to acquire information is very exible thus we introduce exible information acquisition to capture this interaction we show that debt is uniquely optimal com pared with the security design literature we neither assume monotonicity of the feasible securities nor impose various distributional assumptions on the fundamental or information structures fixed aggregate cash ow and homogeneous information cost are two key factors driving the results jel d86 d82 g32

ex post unbalanced tournaments tournaments create strong incentives under the assumption that the competition between the agents is balanced if at the outset one agent is stronger than the other the tournament is ex ante unbalanced and incentives break down handicaps can in this case restore incentives in practice competing agents are often overall equally strong but have different sorts of strengths then competition will typically be unbalanced ex post and incentives break down but handicaps cannot be used we show how a simple means introducing the possibility of a tie can often resolve the problem we examine under what conditions incentives are maximized by ties