Robust Financial Contracting and Investment

Aifan Ling, Jianjun Miao and Neng Wang

No 28367, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We study how investors' preferences for robustness influence corporate investment, financing, and compensation decisions and valuation in a financial contracting model with agency. We characterize the robust contract and show that early liquidation can be optimal when investors are sufficiently ambiguity averse. We implement the robust contract by debt, equity, cash, and a financial derivative asset. The derivative is used to hedge against the investors' concern that the entrepreneur may be overly optimistic. Our calibrated model generates sizable equity premium and credit spread, and implies that ambiguity aversion lowers Tobin's q; the average investment, and investment volatility. The entrepreneur values the project at an internal rate of return of 3.5% per annum higher than investors do.

JEL-codes: D81 E22 G12 G32 J33 (search for similar items in EconPapers)
Date: 2021-01
New Economics Papers: this item is included in nep-cta, nep-mac, nep-mic, nep-ppm and nep-upt
Note: AP CF EFG
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