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.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15192.
Date of creation: Jul 2009
Date of revision:
Note: CF EFG
Contact details of provider:
Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
Web page: http://www.nber.org
More information through EDIRC
Other versions of this item:
- 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 F. Cooley & Sonia B. Di Giannatale, 2010. "A Theory of Firm Decline," Levine's Working Paper Archive 661465000000000149, David K. Levine.
- Sonia Di Giannatale Menegalli & Gian Luca Clementi & Thomas Cooley, 2008. "A Theory of Firm Decline," Documentos de Trabajo DTE 445, CIDE, Division de Economia.
- 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 Giannatal, 2010. "A Theory of Firm Decline," Working Papers 2010.88, Fondazione Eni Enrico Mattei.
- 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)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Khan, Aubhik & Ravikumar, B., 2001.
"Growth and risk-sharing with private information,"
Journal of Monetary Economics,
Elsevier, vol. 47(3), pages 499-521, June.
- Khan, A. & Ravikumar, B., 1997. "Growth and Risk-Sharing with Private Information," Working Papers 97-13, University of Iowa, Department of Economics.
- Aubhik Khan & B. Ravikumar, 1998. "Growth and Risk-Sharing with Private Information," Macroeconomics 9802003, EconWPA.
- Aubhik Khan & B. Ravikumar, 1999. "Growth and risk-sharing with private information," Working Papers 99-12, Federal Reserve Bank of Philadelphia.
- Ana Fernandes & Christopher Phelan, 1999.
"A recursive formulation for repeated agency with history dependence,"
259, Federal Reserve Bank of Minneapolis.
- Fernandes, Ana & Phelan, Christopher, 2000. "A Recursive Formulation for Repeated Agency with History Dependence," Journal of Economic Theory, Elsevier, vol. 91(2), pages 223-247, April.
- Sandro Brusco & Eva Ropero, 2007. "Financing Constraints and Firm Dynamics with Durable Capital," Department of Economics Working Papers 07-08, Stony Brook University, Department of Economics.
- Espino, Emilio, 2004.
"On Ramsey's Conjecture: Efficient Allocations in the Neoclassical Growth Model with Private Information,"
154, Institute for Advanced Studies.
- Espino, Emilio, 2005. "On Ramsey's conjecture: efficient allocations in the neoclassical growth model with private information," Journal of Economic Theory, Elsevier, vol. 121(2), pages 192-213, April.
- Bohacek Radim, 2005. "Capital Accumulation in Private Information Economies," The B.E. Journal of Macroeconomics, De Gruyter, vol. 5(1), pages 1-24, December.
- Peter M. Demarzo & Michael J. Fishman & Zhiguo He & Neng Wang, 2012.
"Dynamic Agency and the q Theory of Investment,"
Journal of Finance,
American Finance Association, vol. 67(6), pages 2295-2340, December.
- Tsyrennikov, Viktor, 2013. "Capital flows under moral hazard," Journal of Monetary Economics, Elsevier, vol. 60(1), pages 92-108.
- Mele, Antonio, 2011.
"Repeated moral hazard and recursive Lagrangeans,"
30310, University Library of Munich, Germany.
- Emilio Espino, 2012. "Investment and Insurance in an Economic Union," 2012 Meeting Papers 1176, Society for Economic Dynamics.
- Loderer, Claudio & Waelchli, Urs, 2010. "Firm age and performance," MPRA Paper 26450, University Library of Munich, Germany.
- Hengjie Ai & Rui Li, 2012. "Moral hazard, investment, and firm dynamics," CQER Working Paper 2012-01, Federal Reserve Bank of Atlanta.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.