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Optimality of Investment under Imperfectly Enforceable Financial Contracts

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  • Hsiao-Lei Chu
  • Nan-Kuang Chen

Abstract

We investigate the optimality of aggregate investment and its policy implications under an environment in which financial contracts are imperfectly enforceable. We show that too much investment occurs when the ratio of own capital to debt is smaller than the ratio of project returns in terms of future values across periods, and too low investment occurs otherwise. A subsidy (tax) on the risk-free interest income can close the over- (under-) investment gap, but this policy may not be welfare improving. Copyright 2003, Oxford University Press.

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  • Hsiao-Lei Chu & Nan-Kuang Chen, 2003. "Optimality of Investment under Imperfectly Enforceable Financial Contracts," Economic Inquiry, Western Economic Association International, vol. 41(2), pages 318-324, April.
  • Handle: RePEc:oup:ecinqu:v:41:y:2003:i:2:p:318-324
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    File URL: http://hdl.handle.net/10.1093/ei/cbg011
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    Cited by:

    1. Nan-Kuang Chen & Charles Leung, 2008. "Asset Price Spillover, Collateral and Crises: with an Application to Property Market Policy," The Journal of Real Estate Finance and Economics, Springer, vol. 37(4), pages 351-385, November.

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