Alternative Solutions to Underinvestment, Under Equity and Credit Rationing

Yoram Kroll and Assaf Cohen

Journal of Business Finance & Accounting, 2000, vol. 27, issue 3‐4, 395-421

Abstract: We compare alternative solutions to underinvestment (UI) problems in firms subject to limited access to equity markets, interest ceilings, and constraints on the volume of debt. Collaterals (assets or compensating balances) and credit insurance (‘regular’ or ‘outcome’ insurance whereby the premium is paid at the end of the insurance period) are compared on the basis to their costs and their effective use of financial sources. It is shown that when there is no moral hazard problem, credit insurance is the most effective instrument. Otherwise, ‘outcome’ insurance program is the most effective one.

Date: 2000
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