Financial Contracting under Risk Neutrality, Limited Liability and Ex ante Asymmetric Information

Economica, 1993, vol. 60, issue 237, pages 27-40

Abstract: This paper derives equilibrium financial contract forms in a risk-neutral capital market with asymmetrically informed borrowers/entrepreneurs and investors. In doing so, the analysis generalizes the work of D. DeMeza and D. Webb (1987) by allowing for arbitrary profit distributions, arbitrary contract forms, and variab le investment choices. The main result of this inquiry is as follows. W hen higher-quality entrepreneurs have "better" ex post profit distributions (in the sense of the monotone likelihood ratio propert y), equilibrium contracts take a standard debt form so long as admissibl e investor payoff functions are monotone nondecreasing in firm profit. Without the monotonicity constraint, contracts often take a differen t, "live-or-die" form. Copyright 1993 by The London School of Economics and Political Science.

Date: 1993
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