Despite the cogent criticism that "bailing out" insolvent firms creates moral hazard, bailouts often occur in the aftermath of bank runs and other financial crises. In an environment where it is economically efficient to make illiquid investments, and where investors have private information regarding their respective liquidity risks, the investment contract must satisfy an incentive constraint. Limited liability tightens this constraint under laissez faire. In principle, government bailouts of insolvent firms might undo this adverse effect of limited liability. A theoretical example is constructed in which bailing out an insolvent corporate sector in some states of the world is essential to implementing efficient investment in a limited-liability regime. This example illustrates the beneficial constraint-relaxation effect of a bailout but abstracts from the moral hazard problem against which it must be weighed.
Volume (Year): (2010)
Issue (Month): 1Q ()
|Contact details of provider:|| Web page: http://www.richmondfed.org/|
More information through EDIRC
|Order Information:|| Web: http://www.richmondfed.org/publications/ Email: |
References listed on IDEAS
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.:
- Acharya, Viral V & Gale, Douglas M & Yorulmazer, Tanju, 2009.
"Rollover Risk and Market Freezes,"
CEPR Discussion Papers
7122, C.E.P.R. Discussion Papers.
When requesting a correction, please mention this item's handle: RePEc:fip:fedreq:y:2010:i:1q:p:11-32:n:v.96no.1. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (William Perkins)
If references are entirely missing, you can add them using this form.