Optimal extended liability rule in a competitive financial market with heterogeneous borrower firms

Hiroyuki Seshimo

Journal of Mathematical Economics, 2022, vol. 98, issue C

Abstract: This paper provides a perspective that unifies two controversial arguments about the extended liability rule in a competitive financial market, i.e., the negative arguments about the exaggeration of the judgment proof problem and the positive arguments about the entry deterrence of inefficient firms. This paper also gives the theoretical solution for the optimality of the extended liability rule. In this paper, heterogeneous firms are assumed for the cost parameter of the precautionary effort, and distortions are dependent on the heterogeneities. Then, even considering extended liability with any share to the financier, the extended liability rule never achieves a socially first-best situation. Alternatively, the conditions under which the second-best optimal extended share to the financier should suffice are provided. Furthermore, I discover that the information structure is one of the crucial factors in determining the socially second-best solution for the extended share.

Keywords: Extended liability; Judgment proof problem; Entry deterrence; Financial contract (search for similar items in EconPapers)
Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:eee:mateco:v:98:y:2022:i:c:s030440682100135x

DOI: 10.1016/j.jmateco.2021.102572

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