Optimal financial contracts with unobservable investments

Mario Tirelli ()

MPRA Paper from University Library of Munich, Germany

Abstract: In this article we propose a security-design problem in which risk neutral entrepreneurs make unobservable investment decisions while employing the investment funds of risk-neutral outside investor/creditor(s). Contracts are restricted to satisfy limited liability and monotonicity of the payment schedule. The model we present extends the classical one proposed by Innes (1990, Journal of Economic Theory 52, 47-67) along three main directions: agents' decisions may be restricted by their initial capital and outside financial opportunities; their investment decisions may also consist in hiding funds in an asset placed outside their firms; initial firms' capital, which identifies entrepreneur types, may only be imperfectly observed by creditors (i.e. types are private information). We motivate our interest in this security-design problem referring to the 'opacity' that often characterizes the financial situation and decisions of small firms, a particularly large fraction of the non-financial sector in most developed countries.

Keywords: Security design; asymmetric information; moral hazard; investment decisions; firm financial structure; debt contracts, collateral. (search for similar items in EconPapers)
JEL-codes: D82 D86 G11 G32 (search for similar items in EconPapers)
Date: 2018-02
New Economics Papers: this item is included in nep-cfn, nep-ent and nep-mic
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https://mpra.ub.uni-muenchen.de/86444/1/MPRA_paper_86444.pdf original version (application/pdf)
https://mpra.ub.uni-muenchen.de/87929/1/MPRA_paper_87929.pdf revised version (application/pdf)

Related works:
Working Paper: OPTIMAL FINANCIAL CONTRACTS WITH UNOBSERVABLE INVESTMENTS (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:86444

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