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Exit Options in Corporate Finance: Liquidity versus Incentives

  • Philippe Aghion
  • Patrick Bolton
  • Jean Tirole

This paper provides a first study of the optimal design of active monitors' exit options in a problem involving a demand for liquidity and costly monitoring of the issuer. Optimal incentives to monitor the issuer may involve restricting the monitor's right to sell her claims on the firm's cash-flow early. But the monitor will then require a liquidity premium for holding such an illiquid claim. In general, therefore, there will be a trade off between incentives and liquidity. The paper highlights a fundamental complementarity between speculative monitoring in financial markets (which increases the informativeness of prices) and active monitoring inside the firm: in financial markets where price discovery is better and securities prices reflect the fundamentals of the issuer better, the incentive cost of greater liquidity may be smaller and active monitoring incentives may be preserved. The paper spells out the conditions under which more or less liquidity is warranted and applies the analysis to shed light on common exit provisions in venture capital financing. Copyright 2004, Oxford University Press.

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File URL: http://hdl.handle.net/10.1007/s10679-004-2542-0
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Article provided by Springer in its journal Review of Finance.

Volume (Year): 8 (2004)
Issue (Month): 3 ()
Pages: 327-353

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Handle: RePEc:kap:eurfin:v:8:y:2004:i:3:p:327-353
Contact details of provider: Web page: http://springerlink.metapress.com/link.asp?id=111870

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  1. Rajan, Raghuram G, 1992. " Insiders and Outsiders: The Choice between Informed and Arm's-Length Debt," Journal of Finance, American Finance Association, vol. 47(4), pages 1367-400, September.
  2. Holmstrom, Bengt & Tirole, Jean, 1993. "Market Liquidity and Performance Monitoring," Journal of Political Economy, University of Chicago Press, vol. 101(4), pages 678-709, August.
  3. Ma, Ching-to Albert, 1991. "Adverse Selection in Dynamic Moral Hazard," The Quarterly Journal of Economics, MIT Press, vol. 106(1), pages 255-75, February.
  4. Bolton, P. & von Thadden, E.L., 1996. "Blocks, liquidity and corporate control," Discussion Paper 1996-80, Tilburg University, Center for Economic Research.
  5. Bhide, Amar, 1993. "The hidden costs of stock market liquidity," Journal of Financial Economics, Elsevier, vol. 34(1), pages 31-51, August.
  6. Sahlman, William A., 1990. "The structure and governance of venture-capital organizations," Journal of Financial Economics, Elsevier, vol. 27(2), pages 473-521, October.
  7. Lerner, Joshua, 1994. "Venture capitalists and the decision to go public," Journal of Financial Economics, Elsevier, vol. 35(3), pages 293-316, June.
  8. Barry, Christopher B. & Muscarella, Chris J. & Peavy, John III & Vetsuypens, Michael R., 1990. "The role of venture capital in the creation of public companies*1: Evidence from the going-public process," Journal of Financial Economics, Elsevier, vol. 27(2), pages 447-471, October.
  9. Berglof, Erik, 1994. "A Control Theory of Venture Capital Finance," Journal of Law, Economics and Organization, Oxford University Press, vol. 10(2), pages 247-67, October.
  10. Matthews, Steven A, 1995. "Renegotiation of Sales Contracts," Econometrica, Econometric Society, vol. 63(3), pages 567-89, May.
  11. Fudenberg, Drew & Tirole, Jean, 1990. "Moral Hazard and Renegotiation in Agency Contracts," Econometrica, Econometric Society, vol. 58(6), pages 1279-1319, November.
  12. Ernst Maug, 1998. "Large Shareholders as Monitors: Is There a Trade-Off between Liquidity and Control?," Journal of Finance, American Finance Association, vol. 53(1), pages 65-98, 02.
  13. Roe, Mark J., 1990. "Political and legal restraints on ownership and control of public companies," Journal of Financial Economics, Elsevier, vol. 27(1), pages 7-41, September.
  14. Gompers, Paul A., 1996. "Grandstanding in the venture capital industry," Journal of Financial Economics, Elsevier, vol. 42(1), pages 133-156, September.
  15. Lerner, Josh, 1995. " Venture Capitalists and the Oversight of Private Firms," Journal of Finance, American Finance Association, vol. 50(1), pages 301-18, March.
  16. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
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