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A Reconsideration of the Jensen-Meckling Model of Outside Finance

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Author Info
Martin Hellwig () (Max Planck Institute for Research on Collective Goods, Bonn)

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Abstract

The paper studies outside finance in a model of two-dimensional moral hazard, involving risk choices as well as effort choices. If the entrepreneur has insu¢ cient funds, a first-best outcome cannot be implemented. Second-best outcomes involve greater failure risk than first-best outcomes. For a Cobb-Douglas technology, second-best effort and investment levels are smaller than first-best; for other technologies, they depend on the elasticity of substitution. If firm returns not too noisy signals of be-haviour, suitable incentives can be provided by some mix of debt and equity issues. If firm returns involve too much noise, this is not possible.

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File URL: http://www.coll.mpg.de/pdf_dat/2007_08online.pdf
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Publisher Info
Paper provided by Max Planck Institute for Research on Collective Goods in its series Working Paper Series of the Max Planck Institute for Research on Collective Goods with number 2007_8.

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Length: 58 pages
Date of creation: Jun 2007
Date of revision:
Handle: RePEc:mpg:wpaper:2007_8

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Related research
Keywords: Financial Contracting; Debt Finance; Equity Finance; Moral Hazard; Risk Choices;

Find related papers by JEL classification:
D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
G30 - Financial Economics - - Corporate Finance and Governance - - - General
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure

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  1. Sundaram, Rangarajan K. & Yermack, David, 2006. "Pay Me Later: Inside Debt and Its Role in Managerial Compensation," SIFR Research Report Series 43, Institute for Financial Research. [Downloadable!]
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This page was last updated on 2009-12-3.


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