Choice of financing mode as a stochastic bounded control problem

Anton Miglo

MPRA Paper from University Library of Munich, Germany

Abstract: In this note I analyze situations where an entrepreneur needs external financing from an outside investor in order to start an investment project that will yield a profit for two consecutive periods. The value of second-period profit is the entrepreneur's private information. I show that the choice of financing mode can be transformed into an optimal stochastic bounded control problem, where the state variable t represents the investor's first-period payoff and the control variable α can be interpreted in terms of the investor's residual profit rights. I then show that under certain general conditions such as the monotonicity and continuity of t (which have clear economic interpretations), an optimal contract is characterized by maximal α under low values of t and minimal α under high values of t. In economic terms this corresponds to debt.

Keywords: optimal financing; stochastic optimization; bounded control; asymmetric information; debt (search for similar items in EconPapers)
JEL-codes: C6 C61 C79 G3 G32 (search for similar items in EconPapers)
Date: 2014
New Economics Papers: this item is included in nep-cta
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