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Disputes, Debt and Equity

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  • Alfred Duncan
  • Charles Nolan

Abstract

We show how the prospect of disputes over firms’ revenue reports promotes debt financing over equity. These findings are presented within a costly state verification model with a risk averse entrepreneur. The prospect of disputes encourages incentive regimes which limit penalties and avoid stochastic monitoring, even when the lender can commit to stochastic enforcement strategies. Consequently, optimal contracts shift away from equity and toward standard debt. For a useful special case of the model, closed form solutions are presented for leverage and consumption allocations under efficient debt contracts.

Suggested Citation

  • Alfred Duncan & Charles Nolan, 2014. "Disputes, Debt and Equity," Working Papers 2014_20, Business School - Economics, University of Glasgow.
    • Handle: RePEc:gla:glaewp:2014_20
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    Cited by:

    1. Le, Vo Phuong Mai & Meenagh, David & Minford, Patrick, 2016. "Monetarism rides again? US monetary policy in a world of Quantitative Easing," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 44(C), pages 85-102.
    2. Alfred Duncan & Charles Nolan, 2020. "Reform of the UK Financial Policy Committee," Scottish Journal of Political Economy, Scottish Economic Society, vol. 67(1), pages 1-30, February.
    3. Duncan, Alfred J. M. & Nolan, Charles, 2019. "Disputes, debt and equity," Theoretical Economics, Econometric Society, vol. 14(3), July.
    4. Alfred Duncan & Joao Pedro De Camargo Mainente & Charles Nolan, 2024. "Monetary and Finacial Policy with Privately Optimal Risk Taking," Working Papers 2024_12, Business School - Economics, University of Glasgow.
    5. Alfred Duncan & Charles Nolan, 2015. "Objectives and Challenges of Macroprudential Policy," Working Papers 2015_22, Business School - Economics, University of Glasgow.
    6. Alfred Duncan & Charles Nolan, 2017. "Financial Frictions in Macroeconomic Models," Studies in Economics 1719, School of Economics, University of Kent.

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    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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