Moral Hazard and Capital Structure Dynamics

Mathias Dewatripont (), Patrick Legros and Steven A. Matthews ()

Journal of the European Economic Association, 2003, vol. 1, issue 4, pages 890-930

Abstract: We base a contracting theory for a startup firm on an agency model with observable but nonverifiable effort, and renegotiable contracts. Two essential restrictions on simple contracts are imposed: the entrepreneur must be given limited liability, and the investor's earnings must not decrease in the realized profit of the firm. All message game contracts with pure strategy equilibria (and no third parties) are considered. Within this class of contracts/equilibria, and regardless of who has the renegotiating bargaining power, debt and convertible debt maxi-mize the entrepreneur's incentives to exert effort. These contracts are optimal if the entre-preneur has the bargaining power in renegotiation. If the investor has the bargaining power, the same is true unless debt induces excessive effort. In the latter case, a nondebt simple contract achieves efficiency-the noncontractibility of effort does not lower welfare. Thus, when the noncontractibility of effort matters, our results mirror typical capital structure dynamics: an early use of debt claims, followed by a switch to equity-like claims. (JEL: D820, L140, O261) Copyright (c) 2003 The European Economic Association.

Date: 2003
View citations in EconPapers

Downloads: (external link)
http://www.mitpressjournals.org/doi/pdfplus/10.1162/154247603322493186 link to full text (text/html)
Access to full text is restricted to subscribers.

Related works:
Working Paper: Moral Hazard and Capital Structure Dynamics (2002)
Working Paper: Moral Hazard and Capital Structure Dynamics (2002)
Working Paper: Moral Hazard and Capital Structure Dynamics (2003)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: http://EconPapers.repec.org/RePEc:tpr:jeurec:v:1:y:2003:i:4:p:890-930

Ordering information: This journal article can be ordered from
http://www.mitpressjournals.org/jeea

Access Statistics for this article

Journal of the European Economic Association is edited by Xavier Vives, George-Marios Angeletos, Orazio P. Attanasio, Fabio Canova and Roberto Perotti

More articles in Journal of the European Economic Association from MIT Press
Series data maintained by Christopher F. Baum ().