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Risk aversion and incentive compatibility with ex post information asymmetry

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  • Hellwig, Martin

Abstract

The paper extends Diamond’s (1984) analysis of financial contracting with information asymmetry ex post and endogenous ”bankruptcy penalties” to allow for risk aversion of the borrower. The optimality of debt contracts, which Diamond obtained for the case of risk neutrality, is shown to be nonrobust to the introduction of risk aversion. This contrasts with the costly state verification literature, in which debt contracts are optimal for risk averse as well as risk neutral borrowers.

Suggested Citation

  • Hellwig, Martin, 1998. "Risk aversion and incentive compatibility with ex post information asymmetry," Papers 98-38, Sonderforschungsbreich 504.
    • Handle: RePEc:mnh:spaper:2883
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    File URL: https://madoc.bib.uni-mannheim.de/2883/1/dp98_38.pdf
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    References listed on IDEAS

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    1. Martin F. Hellwig, 2000. "Financial Intermediation with Risk Aversion," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 67(4), pages 719-742.
    2. 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.
    3. Douglas W. Diamond, 1984. "Financial Intermediation and Delegated Monitoring," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 51(3), pages 393-414.
    4. 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.
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    2. ATTAR, Andréa, 2003. "Financial contracting along the business cycle," LIDAM Discussion Papers CORE 2003069, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).

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    Keywords

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    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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