A Model of Optimal Government Bailouts
AbstractWe analyze incentive-efficient government bailouts within a canonical model of intra-firm moral hazard. Bailouts exacerbate the moral hazard of firms and managers in two ways. First, they make them less averse to failing. Second, the taxes to fund bailouts dampen their incentives. Nevertheless, if third-party externalities from keeping the firm alive are strong, bailouts can improve welfare. Our model suggests that governments should use bailouts sparingly, where social externalities are large and subsidies small; eliminate incumbent owners and managers to improve a priori incentives; and finance bailouts through redistributive taxes on productive firms instead of forcing recipients to repay in the future.
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Bibliographic InfoPaper provided by Berkeley Olin Program in Law & Economics in its series Berkeley Olin Program in Law & Economics, Working Paper Series with number qt8wv4p90c.
Date of creation: 03 Mar 2011
Date of revision:
Government Bailout; Moral Hazard; Law;
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