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A Reconsideration of the Jensen-Meckling Model of Outside Finance

  • Martin Hellwig

    ()

    (Max Planck Institute for Research on Collective Goods, Bonn)

The paper studies outside finance in a model of two-dimensional moral hazard, involving risk choices as well as effort choices. If the entrepreneur has insu¢ cient funds, a first-best outcome cannot be implemented. Second-best outcomes involve greater failure risk than first-best outcomes. For a Cobb-Douglas technology, second-best effort and investment levels are smaller than first-best; for other technologies, they depend on the elasticity of substitution. If firm returns not too noisy signals of be-haviour, suitable incentives can be provided by some mix of debt and equity issues. If firm returns involve too much noise, this is not possible.

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File URL: http://www.coll.mpg.de/pdf_dat/2007_08online.pdf
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Paper provided by Max Planck Institute for Research on Collective Goods in its series Working Paper Series of the Max Planck Institute for Research on Collective Goods with number 2007_8.

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Length: 58 pages
Date of creation: Jun 2007
Date of revision:
Handle: RePEc:mpg:wpaper:2007_8
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  1. Dionne, G. & Viala, P., 1992. "Optimal Design of Financial Contracts and Moral Hazard," Cahiers de recherche 9219, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
  2. Caillaud, Bernard & Guesnerie, Roger & Rey, Patrick, 1989. "Noisy observation in adverse selection models," CEPREMAP Working Papers (Couverture Orange) 8921, CEPREMAP.
  3. 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.
  4. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
  5. Bengt Holmstrom & Paul R. Milgrom, 1985. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Cowles Foundation Discussion Papers 742, Cowles Foundation for Research in Economics, Yale University.
  6. Robert Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis.
  7. Gale, Douglas & Hellwig, Martin, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," Review of Economic Studies, Wiley Blackwell, vol. 52(4), pages 647-63, October.
  8. Bester,Helmut Hellwig,Martin, 1987. "Moral hazard and equilibrium credit rationing: An overview of the issues," Discussion Paper Serie A 125, University of Bonn, Germany.
  9. Harris, Milton & Raviv, Artur, 1991. " The Theory of Capital Structure," Journal of Finance, American Finance Association, vol. 46(1), pages 297-355, March.
  10. Aghion, Philippe & Bolton, Patrick, 1989. "The financial structure of the firm and the problem of control," European Economic Review, Elsevier, vol. 33(2-3), pages 286-293, March.
  11. Hart, Oliver, 1995. "Firms, Contracts, and Financial Structure," OUP Catalogue, Oxford University Press, number 9780198288817.
  12. Patrick Bolton & Mathias Dewatripont, 2005. "Contract Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262025760, June.
  13. 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.
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