A Theory of Firm Decline
AbstractWe study the problem of an investor who buys an equity stake in an entrepreneurial venture, under the assumption that the former cannot monitor the latter’s operations. The dynamics implied by the optimal incentive scheme is rich and quite different from that induced by other models of repeated moral hazard. In particular, our framework generates a rationale for firm decline. As young firms accumulate capital, the claims of both investor (outside equity) and entrepreneur (inside equity) increase. At some juncture, however, even as the latter keeps on growing, invested capital and firm value start declining and so does the value of outside equity. The reason is that incentive provision is costlier the wealthier the entrepreneur (the greater is inside equity). In turn, this leads to a decline in the constrained–efficient level of effort and therefore to a drop in the return to investment.
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Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15192.
Date of creation: Jul 2009
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Other versions of this item:
- Gian Luca Clementi & Thomas F. Cooley & Sonia DiGiannatale, 2009. "A Theory of Firm Decline," Working Papers 09-05, New York University, Leonard N. Stern School of Business, Department of Economics.
- Gian Luca Clementi & Thomas Cooley & Sonia Di Giannatale, 2008. "A Theory of Firm Decline," Working Paper Series 33-08, The Rimini Centre for Economic Analysis, revised Jan 2008.
- Gian Luca Clementi & Thomas Cooley & Sonia Di Giannatal, 2010. "A Theory of Firm Decline," Working Papers 2010.88, Fondazione Eni Enrico Mattei.
- Gian Luca Clementi & Thomas F. Cooley & Sonia B. Di Giannatale, 2010. "A Theory of Firm Decline," Levine's Working Paper Archive 661465000000000149, David K. Levine.
- E0 - Macroeconomics and Monetary Economics - - General
- L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-08-02 (All new papers)
- NEP-BEC-2009-08-02 (Business Economics)
- NEP-CTA-2009-08-02 (Contract Theory & Applications)
- NEP-ENT-2009-08-02 (Entrepreneurship)
- NEP-SBM-2009-08-02 (Small Business Management)
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