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Financial Contracting under Risk Neutrality, Limited Liability and Ex ante Asymmetric Information

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  • Innes, Robert

Abstract

This paper derives equilibrium financial contract forms in a risk-neutral capital market with asymmetrically informed borrowers/entrepreneurs and investors. In doing so, the analysis generalizes the work of D. DeMeza and D. Webb (1987) by allowing for arbitrary profit distributions, arbitrary contract forms, and variab le investment choices. The main result of this inquiry is as follows. W hen higher-quality entrepreneurs have "better" ex post profit distributions (in the sense of the monotone likelihood ratio propert y), equilibrium contracts take a standard debt form so long as admissibl e investor payoff functions are monotone nondecreasing in firm profit. Without the monotonicity constraint, contracts often take a differen t, "live-or-die" form. Copyright 1993 by The London School of Economics and Political Science.

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Bibliographic Info

Article provided by London School of Economics and Political Science in its journal Economica.

Volume (Year): 60 (1993)
Issue (Month): 237 (February)
Pages: 27-40

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Handle: RePEc:bla:econom:v:60:y:1993:i:237:p:27-40

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Cited by:
  1. Roosen, Jutta & Hennessy, David A., 2003. "Testing for the Monotone Likelihood Ratio Assumption," Staff General Research Papers 10193, Iowa State University, Department of Economics.
  2. Florian Scheuer, 2012. "Adverse Selection In Credit Markets and Regressive Profit Taxation," NBER Working Papers 18406, National Bureau of Economic Research, Inc.
  3. Eren Inci, 2007. "Occupational Choice and the Quality of Entrepreneurs," Boston College Working Papers in Economics 666, Boston College Department of Economics.
  4. Kosmas Marinakis & Theofanis Tsoulouhas, 2012. "A comparison of cardinal tournaments and piece rate contracts with liquidity constrained agents," Journal of Economics, Springer, vol. 105(2), pages 161-190, March.
  5. Jose E. Quintero Jaramillo, 2004. "Moral Hazard In Teams With Limited Punishments And Multiple Outputs," Business Economics Working Papers wb040705, Universidad Carlos III, Departamento de Economía de la Empresa.
  6. Jose E. Quintero Jaramillo, 2004. "Liquidity Constraints And Credit Subsidies In Auctions," Business Economics Working Papers wb040604, Universidad Carlos III, Departamento de Economía de la Empresa.
  7. Gersbach, Hans & Uhlig, Harald, 2006. "Debt contracts and collapse as competition phenomena," Journal of Financial Intermediation, Elsevier, vol. 15(4), pages 556-574, October.
  8. Marinakis, Kosmas & Tsoulouhas, Theofanis, 2013. "Are tournaments optimal over piece rates under limited liability for the principal?," International Journal of Industrial Organization, Elsevier, vol. 31(3), pages 223-237.
  9. Vauhkonen, Jukka, 2003. "Are adverse selection models of debt robust to changes in market structure?," Research Discussion Papers 28/2003, Bank of Finland.

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