A Reconsideration of the Jensen-Meckling Model of Outside Finance

Martin Hellwig

No 2007_8, Discussion Paper Series of the Max Planck Institute for Research on Collective Goods from Max Planck Institute for Research on Collective Goods

Abstract: The paper studies outside finance in a model of two-dimensional moral hazard, involving risk choices as well as effort choices. If the entrepreneur has insu¢ cient funds, a first-best outcome cannot be implemented. Second-best outcomes involve greater failure risk than first-best outcomes. For a Cobb-Douglas technology, second-best effort and investment levels are smaller than first-best; for other technologies, they depend on the elasticity of substitution. If firm returns not too noisy signals of be-haviour, suitable incentives can be provided by some mix of debt and equity issues. If firm returns involve too much noise, this is not possible.

Keywords: Financial Contracting; Debt Finance; Equity Finance; Moral Hazard; Risk Choices (search for similar items in EconPapers)
JEL-codes: D86 G30 G32 (search for similar items in EconPapers)
Pages: 58 pages
Date: 2007-06
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Citations: View citations in EconPapers (1)

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Related works:
Journal Article: A reconsideration of the Jensen-Meckling model of outside finance (2009)
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