Dynamic Financial Contracting with Persistent Private Information

R. Vijay Krishna and Shiming Fu
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R. Vijay Krishna: Duke University
Shiming Fu: University of Rochester

No 89, 2016 Meeting Papers from Society for Economic Dynamics

Abstract: This paper studies a dynamic agency model in which the agent privately observes the firm's cash flows that are subject to persistent shocks. We characterize the optimal contract by continuation utilities contingent on the agent's report today and tomorrow. The optimal contract can be implemented by a contingent credit line, stock options, and equity. In contrast to the iid case, we find: (i) investment is possibly efficient in the constrained firm, and is varying with cash flow in the unconstrained firm; (ii) the firm possibly experiences longer time of being financially constrained; (iii) the agent receives cash payment less than what he can divert from cash flow and investors hold more equity stake; (iv) compensation to the agent is via stock options and equity, the combination of which depends on persistence level; (v) firm credit line limits are contingent on compliance with a cash flow covenant and are history dependent.

Date: 2016
New Economics Papers: this item is included in nep-cta, nep-ger and nep-mic
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:red:sed016:89

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