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Are two investors better than one?

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Abstract

This paper compares the optimal investor repayment contracts of a firm which has private information over its expost revenues when the finance can be provided by a single or by two investors (say a big shareholder and a group of small dispersed shareholders). Costly monitoring can be carried out by those investors who have a larger stake into the contract. When they are the only investors we use the Khalil-Parigi financial contract with non-contractible monitoring, in which the probabilities of cheating by the firm and monitoring by investors are mutual best responses. The contract is written by the firm knowing that this equilibrium will subsequently occur. With a second group of investors who have no monitoring rights, cheating and monitoring probabilities are chosen in a similar way. The small shareholders learn the results of any monitoring for free. A main result is that without commitment there is a negative correlation between repayments to the two investor groups: the contract uses the small group to smooth out the repayments of the firm optimally. This reduces the incentive for the firm to make false reports and mitigates the investor's incentive to monitor. A second result is that the two investor scenario is Pareto superior to the single investor model. A third result is that the possible extent of this smoothing depends on whether the investors have limited liability; it is found that in some circumstances investors should make repayments to the firm rather than receive them.

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  • Annamaria Menichini & Peter Simmons, 2001. "Are two investors better than one?," CSEF Working Papers 71, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
  • Handle: RePEc:sef:csefwp:71
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    File URL: http://www.csef.it/WP/wp71.pdf
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    Cited by:

    1. Karel Janda, 2007. "Optimal Debt Contracts in Emerging Markets with Multiple Investors," Prague Economic Papers, University of Economics, Prague, vol. 2007(2), pages 115-129.

    More about this item

    Keywords

    contracts; multiple investors; no commitment;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness

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