Limited Liability and Option Contracts in Models with Sequential Investments
AbstractThe paper investigates a model where two parties sequentially invest in a joint project (an asset). Investments and the project value are unverifiable, and A is wealth constrained so that an initial outlay must be financed by either agent B or an external investor C, say a bank. We show that an option contract in combination with a loan arrangement facilitates first best investments and any distribution of surplus if renegotiation is infeasible. Moreover, the optimal strike price of the option is shown to differ across financing modes. If renegotiation is admitted, the first best can still be attained unless A's bargaining position is too strong. Otherwise, B financing or C financing may become strictly preferable, and a combination of multiple lenders may be optimal.
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Bibliographic InfoPaper provided by University of Bonn, Germany in its series Bonn Econ Discussion Papers with number bgse27_2001.
Date of creation: Jul 2001
Date of revision:
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Option Contracts; Corporate Finance; Sequential Investments; Double Moral Hazard;
Find related papers by JEL classification:
- D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
- H57 - Public Economics - - National Government Expenditures and Related Policies - - - Procurement
- L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2002-02-10 (All new papers)
- NEP-ENT-2002-02-10 (Entrepreneurship)
- NEP-PBE-2002-02-10 (Public Economics)
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