IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this paper

Moral Hazard and Capital Structure Dynamics

Listed author(s):
  • Mathias Dewatripont
  • Patrick Legros
  • Steven A. Matthews

We base a contracting theory for a startup firm on an agency model with observable but nonverifiable effort, and renegotiable contracts. Two essential restrictions on simple contracts are imposed: the entrepreneur must be given limited liability, and the investor's earnings must not decrease in the realized profit of the firm. All message game contracts with pure strategy equilibria (and no third parties) are considered. Within this class of contracts/equilibria, and regardless of who has the renegotiating bargaining power, debt and convertible debt maximize the entrepreneur's incentives to exert effort. These contracts are optimal if the entrepreneur has the bargaining power in renegotiation. If the investor has the bargaining power, the same is true unless debt induces excessive effort. In the latter case, a nondebt simple contract achieves efficiency-the noncontractibility of effort does not lower welfare. Thus, when the noncontractibility of effort matters, our results mirror typical capital structure dynamics: an early use of debt claims, followed by a switch to equity-like claims. © 2003 by the European Economic Association.

(This abstract was borrowed from another version of this item.)

If 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.

File URL: http://www.econ.upenn.edu/Centers/CARESS/CARESSpdf/02-07.pdf
Download Restriction: no

Paper provided by Penn Economics Department in its series Penn CARESS Working Papers with number dfdfbbfe0a5b0e04217a58a9319b4963.

as
in new window

Length:
Date of creation: Jul 2002
Handle: RePEc:cla:penntw:dfdfbbfe0a5b0e04217a58a9319b4963
Contact details of provider: Web page: http://www.dklevine.com/

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.:

as
in new window


  1. Aghion, Philippe & Dewatripont, Mathias & Rey, Patrick, 1994. "Renegotiation Design with Unverifiable Information," Scholarly Articles 12375014, Harvard University Department of Economics.
  2. Steven N. Kaplan & Per Strömberg, 2003. "Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts," Review of Economic Studies, Oxford University Press, vol. 70(2), pages 281-315.
  3. Fudenberg, Drew & Tirole, Jean, 1990. "Moral Hazard and Renegotiation in Agency Contracts," Econometrica, Econometric Society, vol. 58(6), pages 1279-1319, November.
  4. Casamatta, Catherine, 2002. "Financing and Advising: Optimal Financial Contracts with Venture Capitalists," CEPR Discussion Papers 3475, C.E.P.R. Discussion Papers.
  5. Matthews, Steven A, 1995. "Renegotiation of Sales Contracts," Econometrica, Econometric Society, vol. 63(3), pages 567-589, May.
  6. Oliver Hart & John Moore, 1998. "Foundations of Incomplete Contracts," NBER Working Papers 6726, National Bureau of Economic Research, Inc.
  7. Mathias Dewatripont & Jean Tirole, 1994. "A theory of debt and equity: diversity of securities and manager-shareholder congruence," ULB Institutional Repository 2013/9593, ULB -- Universite Libre de Bruxelles.
  8. Berglof, Erik, 1994. "A Control Theory of Venture Capital Finance," Journal of Law, Economics and Organization, Oxford University Press, vol. 10(2), pages 247-267, October.
  9. Steven Matthews, "undated". "Renegotiating Moral Hazard Contracts Under Limited Liability and Monotonicity," CARESS Working Papres 99-04, University of Pennsylvania Center for Analytic Research and Economics in the Social Sciences.
  10. Oliver Hart & John Moore, 1994. "A Theory of Debt Based on the Inalienability of Human Capital," The Quarterly Journal of Economics, Oxford University Press, vol. 109(4), pages 841-879.
  11. Aumann, Robert J. & Heifetz, Aviad, 2002. "Incomplete information," Handbook of Game Theory with Economic Applications, in: R.J. Aumann & S. Hart (ed.), Handbook of Game Theory with Economic Applications, edition 1, volume 3, chapter 43, pages 1665-1686 Elsevier.
  12. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
  13. Bergemann, Dirk & Hege, Ulrich, 1997. "Venture Capital Financing, Moral Hazard and Learning," CEPR Discussion Papers 1738, C.E.P.R. Discussion Papers.
  14. Che, Y.K. & Hausch, D.B., 1997. "Cooperative Investments and the Value of Contracting," Working papers 9714, Wisconsin Madison - Social Systems.
  15. Cornelli, Francesca & Yosha, Oved, 1997. "Stage Financing and the Role of Convertible Debt," CEPR Discussion Papers 1735, C.E.P.R. Discussion Papers.
  16. Cornelli, F. & Yosha, O., 1997. "Stage Financing and the Role of Convertible Debt," Papers 23-97, Tel Aviv.
  17. Hart, Oliver D & Moore, John, 1988. "Incomplete Contracts and Renegotiation," Econometrica, Econometric Society, vol. 56(4), pages 755-785, July.
  18. Roberta Dessï¾’, 2005. "Start-Up Finance, Monitoring, and Collusion," RAND Journal of Economics, The RAND Corporation, vol. 36(2), pages 255-274, Summer.
  19. Hermalin, Benjamin E & Katz, Michael L, 1991. "Moral Hazard and Verifiability: The Effects of Renegotiation in Agency," Econometrica, Econometric Society, vol. 59(6), pages 1735-1753, November.
  20. Klaus M. Schmidt, 2003. "Convertible Securities and Venture Capital Finance," Journal of Finance, American Finance Association, vol. 58(3), pages 1139-1166, 06.
  21. Ching-to Albert Ma, 1990. "Renegotiation and Optimality in Agency Contracts," Papers 0004, Boston University - Industry Studies Programme.
  22. Susan Athey, 2002. "Monotone Comparative Statics under Uncertainty," The Quarterly Journal of Economics, Oxford University Press, vol. 117(1), pages 187-223.
  23. Sanford J Grossman & Oliver D Hart, 2001. "An Analysis of the Principal-Agent Problem," Levine's Working Paper Archive 391749000000000339, David K. Levine.
  24. Eric Maskin, 1998. "Nash Equilibrium and Welfare Optimality," Harvard Institute of Economic Research Working Papers 1829, Harvard - Institute of Economic Research.
  25. Eric Maskin & John Moore, 1999. "Implementation and Renegotiation," Harvard Institute of Economic Research Working Papers 1863, Harvard - Institute of Economic Research.
  26. Steven N. Kaplan & Per Stromberg, 2002. "Characteristics, Contracts, and Actions: Evidence from Venture Capitalist Analyses," NBER Working Papers 8764, National Bureau of Economic Research, Inc.
  27. Innes, Robert D., 1990. "Limited liability and incentive contracting with ex-ante action choices," Journal of Economic Theory, Elsevier, vol. 52(1), pages 45-67, October.
  28. Sahlman, William A., 1990. "The structure and governance of venture-capital organizations," Journal of Financial Economics, Elsevier, vol. 27(2), pages 473-521, October.
  29. J. A. Mirrlees, 1999. "The Theory of Moral Hazard and Unobservable Behaviour: Part I," Review of Economic Studies, Oxford University Press, vol. 66(1), pages 3-21.
  30. Douglas W. Diamond, 1991. "Debt Maturity Structure and Liquidity Risk," The Quarterly Journal of Economics, Oxford University Press, vol. 106(3), pages 709-737.
  31. Legros, Patrick & Newman, Andrew F., 2002. "Courts, contracts, and interference," European Economic Review, Elsevier, vol. 46(4-5), pages 734-744, May.
  32. Rogerson, William P, 1985. "The First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 53(6), pages 1357-1367, November.
  33. Green, Richard C., 1984. "Investment incentives, debt, and warrants," Journal of Financial Economics, Elsevier, vol. 13(1), pages 115-136, March.
  34. Jewitt, Ian, 1988. "Justifying the First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 56(5), pages 1177-1190, September.
  35. Philippe Aghion & Patrick Bolton, 1992. "An Incomplete Contracts Approach to Financial Contracting," Review of Economic Studies, Oxford University Press, vol. 59(3), pages 473-494.
  36. Bolton, Patrick & Scharfstein, David S, 1990. "A Theory of Predation Based on Agency Problems in Financial Contracting," American Economic Review, American Economic Association, vol. 80(1), pages 93-106, March.
  37. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
  38. Paul Milgrom & Ilya Segal, 2002. "Envelope Theorems for Arbitrary Choice Sets," Econometrica, Econometric Society, vol. 70(2), pages 583-601, March.
  39. Athey, S, 1996. "Comparative Statics under Uncertainty : Single Crossing Properties and Log-Supermodularity," Working papers 96-22, Massachusetts Institute of Technology (MIT), Department of Economics.
  40. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
  41. Oliver Hart & John Moore, 1998. "Default and Renegotiation: A Dynamic Model of Debt," The Quarterly Journal of Economics, Oxford University Press, vol. 113(1), pages 1-41.
  42. Erik Berglof & Ernst-Ludwig von Thadden, 1994. "Capital Structure with Multiple Investors," CEPR Financial Markets Paper 0044, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 77 Bastwick Street, London EC1V 3PZ..
  43. Douglas Gale & Martin Hellwig, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," Review of Economic Studies, Oxford University Press, vol. 52(4), pages 647-663.
  44. Ching-to Albert Ma, 1991. "Adverse Selection in Dynamic Moral Hazard," The Quarterly Journal of Economics, Oxford University Press, vol. 106(1), pages 255-275.
  45. Ilya Segal & Michael D. Whinston, 2002. "The Mirrlees Approach to Mechanism Design with Renegotiation (with Applications to Hold-up and Risk Sharing)," Econometrica, Econometric Society, vol. 70(1), pages 1-45, January.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:cla:penntw:dfdfbbfe0a5b0e04217a58a9319b4963. 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: (David K. Levine)

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.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.