Gian Luca Clementi () (New York University, USA and The Rimini Centre of Economic Analisys, Italy) Thomas Cooley () (New York University and NBER, USA) Sonia Di Giannatale () (Centro de Investigaci´on y Docencia Econ´omicas, M´exico)
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We study the problem of an investor that 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 andquite 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, capital and firm value start declining and so does the value of outside equity. The reason is that incentive provision becomes costlier as inside equity grows. In turn, this leads to a decline in the constrained–efficient level of effort and therefore to a drop in the return to investment. In the long run, the entrepreneur gains control of all cash–flow rights and the capital stock converges to a constant value.
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Paper provided by Rimini Centre for Economic Analysis in its series Working Paper Series with number
33-08.
Gian Luca Clementi & Thomas F. Cooley & Sonia Di Giannatale, 2009.
"A Theory of Firm Decline,"
NBER Working Papers
15192, National Bureau of Economic Research, Inc.
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Find related papers by JEL classification: D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law D92 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Firm Choice and Growth, Investment, or Financing G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure
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