Security design and firm dynamics under long‐term moral hazard

Alexandre Messa

Applied Stochastic Models in Business and Industry, 2016, vol. 32, issue 6, 852-869

Abstract: This paper addresses a moral hazard problem in which the agent's actions affect the future profits of the firm. The optimal contract can be implemented through the issuance of variable coupon debt and purchase of fixed‐coupon debt. Consequently, the resulting capital structure acts as a hedge for the firm, reducing underinvestment costs in bad states of nature and controlling overinvestment incentives in good ones. However, owing to asymmetric information between the firm's manager and investors, this hedge is only partial. The firm's investments vary with cash flows, disclosing the agent's asymmetric information to the principal. Copyright © 2016 John Wiley & Sons, Ltd.

Date: 2016
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https://doi.org/10.1002/asmb.2208

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Persistent link: https://EconPapers.repec.org/RePEc:wly:apsmbi:v:32:y:2016:i:6:p:852-869

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