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An Assignment Model of Monitored Finance

Author

Listed:
  • Arturo Antón-Sarabia

    (Division of Economics, CIDE)

  • Kaniska Dam

    (Division of Economics, CIDE)

Abstract

We develop an incentive contracting model of firm formation. Entrepreneurs of private equity firms who differ in net worth are required to borrow from institutional investors in order to finance start up projects. Investors, who differ in monitoring efficiency, may choose to monitor their borrowers at a cost. Non-verifiability of both entrepreneurial effort and monitoring gives rise to double-sided moral hazard problems, and leads to market failure. Individuals with high monitoring efficiency invest in lownet worth firms following a negatively assortative matching pattern since monitoring efficiency and net worth are strategic substitutes in mitigating incentive problems. The equilibrium debt obligation of the entrepreneur and expected firm value are in general non-monotone with respect to net worth. We solve the model numerically in order to analyze the effects of changes in the distributions of monitoring efficiency and net worth on the equilibrium loan contracts.

Suggested Citation

  • Arturo Antón-Sarabia & Kaniska Dam, 2015. "An Assignment Model of Monitored Finance," Working Papers DTE 577, CIDE, División de Economía.
    • Handle: RePEc:emc:wpaper:dte577
    as

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    References listed on IDEAS

    as
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    4. Besanko, David & Kanatas, George, 1993. "Credit Market Equilibrium with Bank Monitoring and Moral Hazard," The Review of Financial Studies, Society for Financial Studies, vol. 6(1), pages 213-232.
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    Keywords

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    JEL classification:

    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions
    • I38 - Health, Education, and Welfare - - Welfare, Well-Being, and Poverty - - - Government Programs; Provision and Effects of Welfare Programs
    • J26 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Retirement; Retirement Policies
    • O40 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General

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