Technology choice bias and limited liability

Norman Ireland ()

Economics of Governance, 2004, vol. 5, issue 2, 103-118

Abstract: The effect of limited liability on debt contracts has been analysed as creating the possibility of credit rationing and hence inefficiently low levels of investment. In this paper we instead focus on restrictions on the use of debt finance to avoid moral hazard problems but which add inefficiency by removing management discretion in the investment process. Essentially, the trade-off is between “rules” and “discretion”, and can lead to the wrong choice of technology being adopted. It is shown that this inefficient technology can persist in a steady-state competitive equilibrium. The role of venture capitalists is to reduce this inefficiency both by providing equity rather than debt finance and by involvement in the firm’s management. The latter involvement can counteract other possible agency problems associated with the dilution of the firm’s equity share. Copyright Springer-Verlag Berlin/Heidelberg 2004

Keywords: Technology; moral hazard; venture capitalists (search for similar items in EconPapers)
Date: 2004
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DOI: 10.1007/s10101-003-0069-z

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