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Optimal Long Term Financial Contracting
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Book Synopsis Optimal Long-Term Financial Contracting by : Peter M. DeMarzo
Download or read book Optimal Long-Term Financial Contracting written by Peter M. DeMarzo and published by . This book was released on 2010 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: We develop an agency model of financial contracting. We derive long-term debt, a line of credit, and equity as optimal securities, capturing the debt coupon and maturity; the interest rate and limits on the credit line; inside versus outside equity; dividend policy; and capital structure dynamics. The optimal debt-equity ratio is history dependent, but debt and credit line terms are independent of the amount financed and, in some cases, the severity of the agency problem. In our model, the agent can divert cash flows; we also consider settings in which the agent undertakes hidden effort, or can control cash flow risk.
Book Synopsis Optimal Long-Term Financial Contracting with Privately Observed Cash Flows by : Peter M. DeMarzo
Download or read book Optimal Long-Term Financial Contracting with Privately Observed Cash Flows written by Peter M. DeMarzo and published by . This book was released on 2004 with total page 44 pages. Available in PDF, EPUB and Kindle. Book excerpt: We characterize the optimal long-term financial contract in a setting in which a risk-neutral agent with limited capital seeks financing for a project that pays stochastic cash flows over many periods. These cash flows are observable to the agent but not to investors. The agent can be induced to pay investors via the threat of the loss of control of the project. After solving for the contract as an optimal mechanism, we demonstrate that it can be implemented by a combination of equity, long-term debt and a line of credit - very simple, standard securities. Thus our model provides a theory of capital structure, capturing both optimal debt maturity and debt vs. equity financing. Equity is issued to investors and is also used for the agent's compensation. In equilibrium, the agent may default on the debt and control of the project may pass to debt holders. The optimal capital structure is robust in the sense that it is independent of the amount financed and under certain circumstances, independent of the severity of the moral hazard problem. We also show how our characterization applies to settings in which the agent undertakes hidden effort, or can alter the risk of cash flows.
Book Synopsis A Continuous-time Agency Model of Optimal Contracting and Capital Structure by : Peter M. DeMarzo
Download or read book A Continuous-time Agency Model of Optimal Contracting and Capital Structure written by Peter M. DeMarzo and published by . This book was released on 2004 with total page 45 pages. Available in PDF, EPUB and Kindle. Book excerpt: We consider a principal-agent model in which the agent needs to raise capital from the principal to finance a project. Our model is based on DeMarzo and Fishman (2003), except that the agent's cash flows are given by a Brownian motion with drift in continuous time. The difficulty in writing an appropriate financial contract in this setting is that the agent can conceal and divert cash flows for his own consumption rather than pay back the principal. Alternatively, the agent may reduce the mean of cash flows by not putting in effort. To give the agent incentives to provide effort and repay the principal, a long-term contract specifies the agent's wage and can force termination of the project. Using techniques from stochastic calculus similar to Sannikov (2003), we characterize the optimal contract by a differential equation. We show that this contract is equivalent to the limiting case of a discrete time model with binomial cash flows. The optimal contract can be interpreted as a combination of equity, a credit line, and either long-term debt or a compensating balance requirement (i.e., a cash position). The project is terminated if the agent exhausts the credit line and defaults. Once the credit line is paid off, excess cash flows are used to pay dividends. The agent is compensated with equity alone. Unlike the discrete time setting, our differential equation for the continuous-time model allows us to compute contracts easily, as well as compute comparative statics. The model provides a simple dynamic theory of security design and optimal capital structure.
Book Synopsis Firms, Contracts, and Financial Structure by : Oliver D. Hart
Download or read book Firms, Contracts, and Financial Structure written by Oliver D. Hart and published by Oxford University Press. This book was released on 1995-10-05 with total page 239 pages. Available in PDF, EPUB and Kindle. Book excerpt: This book provides a framework for thinking about economic instiutions such as firms. The basic idea is that institutions arise in situations where people write incomplete contracts and where the allocation of power or control is therefore important. Power and control are not standard concepts in economic theory. The book begins by pointing out that traditional approaches cannot explain on the one hand why all transactions do not take place in one huge firm and on the other handwhy firms matter at all. An incomplete contracting or property rights approach is then developed. It is argued that this approach can throw light on the boundaries of firms and on the meaning of asset ownership. In the remainder of the book, incomplete contacting ideas are applied to understandfirms' financial decisions, in particular, the nature of debt and equity (why equity has votes and creditors have foreclosure rights); the capital structure decisions of public companies; optimal bankruptcy procedure; and the allocation of voting rights across a company's shares. The book is written in a fairly non-technical style and includes many examples. It is aimed at advanced undergraduate and graduate students, academic and business economists, and lawyers as well as those with aninterest in corporate finance, privatization and regulation, and transitional issues in Eastern Europe, the former Soviet Union, and China. Little background knowledge is required, since the concepts are developed as the book progresses and the existing literature is fully reviewed.
Book Synopsis Multiperiod Agency Problems and Financial Contracting by : Subramanyam Venkataraman
Download or read book Multiperiod Agency Problems and Financial Contracting written by Subramanyam Venkataraman and published by . This book was released on 1988 with total page 488 pages. Available in PDF, EPUB and Kindle. Book excerpt:
Book Synopsis Optimal Lending Contract with Uncertainty Shocks by : Alonso Villacorta
Download or read book Optimal Lending Contract with Uncertainty Shocks written by Alonso Villacorta and published by . This book was released on 2014 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: I develop a dynamic agency model of financial contracting, where borrowing constraints appear as part of the optimal contract. The novelty of the paper relative to previous work is that volatility is stochastic and exogenous to the agent behavior. A line of credit appears in the optimal long term contract similar to (DeMarzo and Fishman, 2007). The novelty of the contract is that the credit limit varies over time, as a function of the state of volatility. Credit limit does not vary monotonically over firms. When uncertainty increases, credit limits are reduced for highly constraint firms, because the frictions become harder and the firms lose profitability. Instead, it is optimal to increase the credit limits for less indebted firms, they are still profitable and they need more flexibility to respond to the bigger shocks.
Book Synopsis Financial Contracting with Optimistic Entrepreneurs by : Augustin Landier
Download or read book Financial Contracting with Optimistic Entrepreneurs written by Augustin Landier and published by . This book was released on 2013 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: Optimistic beliefs are a source of nonpecuniary benefits for entrepreneurs that can explain the ldquo;Private Equity Puzzle.rdquo; This paper looks at the effects of entrepreneurial optimism on financial contracting. When the contract space is restricted to debt, we show the existence of a separating equilibrium in which optimists self-select into short-term debt and realists into long-term debt. Long-term debt is optimal for a realist entrepreneur as it smooths payoffs across states of nature. Short-term debt is optimal for optimists for two reasons: (i) ldquo;bridging the gap in beliefsrdquo; by letting the entrepreneur take a bet on his project's success, and (ii) letting the investor impose adaptation decisions in bad states. We test our theory on a large data set of French entrepreneurs. First, in agreement with the psychology literature, we find that biases in beliefs may be (partly) explained by individual characteristics and tend to persist over time. Second, as predicted by our model, we find that short-term debt is robustly correlated with ldquo;optimisticrdquo; expectation errors, even controlling for firm risk and other potential determinants of short-term leverage.
Book Synopsis Short-Term Versus Long-Term Interests by : Erik Berglöf
Download or read book Short-Term Versus Long-Term Interests written by Erik Berglöf and published by . This book was released on 2007 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: We study the problem of financial contracting and renegotiation between a firm and outside investors when the firm cannot commit to future payouts, but assets can be contracted upon. We show that a capital structure with multiple investors specializing in short-term and long-term claims is superior to a structure with only one type of claim. By separating their claims over time and by giving short-term claims priority over long-term claims when debt repayments are not met, investors can harden the incentives for the entrepreneur to renegotiate the contract ex post. Depending on the parameters, the optimal capital structure also differentiates between state-independent and state- dependent long-term claims, which can be interpreted as long-term debt and equity.
Book Synopsis Financial Contracting and Asymmetric Information by : Robert R. Moore
Download or read book Financial Contracting and Asymmetric Information written by Robert R. Moore and published by . This book was released on 1987 with total page 320 pages. Available in PDF, EPUB and Kindle. Book excerpt:
Book Synopsis Essays on Dynamic Contracting by : Ilia Krasikov
Download or read book Essays on Dynamic Contracting written by Ilia Krasikov and published by . This book was released on 2019 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: The thesis focuses on understanding the dynamic nature of contracts used in various economic context, specifically financial economics and industrial organization. The first chapter "A Theory of Dynamic Contracting with Financial Constraints'' draws on a large empirical literature documenting that small businesses are financially constrained, and operate at an inefficient level. In the paper, we build a theoretical model where financial constraints arise endogenously as a product of interaction between persistent agency frictions and agent's inability to raise external capital.The paper makes two general points. First, efficiency is a certainty in the long run, and it is achieved through monotone slacking of financial constraints. Second, persistence makes the path towards efficiency much more constrained in comparison to the model with the iid technology. In particular, we show that dynamic agency models with persistence predict a larger cross section of firms in the economy to be financially constrained.At a technical level, we invoke the recursive approach of \citet{aps}, using a two-dimensional vector of promised utilities as a state variable. We show that the optimal contract always stays in a strict subset of the recursive domain termed the shell, and the optimal contract is monotone within this set. We also verify that the results continue to hold in continuous time.The second chapter "Dynamic Contracts with Unequal Discounting'' looks at dynamic screening with soft financial constraints. In contrast to the first paper, the agent can raise money but at a different rate than the principal.We solve for the optimal contract and show that efficiency is not attainable with soft financial constraints. Therefore, the predictions of dynamic models of mechanism design are not robust to the assumption of equal discounting. For the large set of parameters, the optimal contract has the restart property- dynamic distortions are a function of the number of consecutive bad shocks, and once the good shock arrives the process repeats again. We also show that restricting attention to contracts which have the restart property is in general approximately optimal. The endogenous resetting aspect of restart contracts shares features of various contracts used in practice.In the third chapter "On Dynamic Pricing'', we explore dynamic price discrimination, extending a canonical model of monopolistic screening to repeated sales, where a seller uses timing of purchases as a screening instrument. The importance of time as an instrument for price discrimination has been understood since Varian [1989].In the paper, we are aiming to provide a formal analysis of pricing strategies to discriminate amongst consumers based on the timing of information arrival and/or the timing of purchase.A seller repeatedly trades with a buyer. Buyer's valuations for the trade follow a renewal process; that is, they change infrequently at random dates. For the model with two periods, We show that selling the first period good for a spot price and selling the second period good by optioning a sequence of forwards is the optimal pricing strategy. Specifically, at the outset, the seller offers an American option which can be exercised in each of the two periods. Exercising the option grants the buyer with a forward- an obligation to purchase the second period good for a specific price, and a strike price- a right to buy (or not) the good in the second period after learning his value. The buyer with a high valuation exercises the option in the first period, whereas one with a low valuation waits until the second period and then takes a call.We extend the analysis to the general continuous time renewal processes and assess the performance of price discrimination based on American options on forwards:i.optioning forwards is shown to be the deterministic optimum for the sequential screening problem- when the seller makes a sale in a single fixed period;ii.optioning forwards is shown to be the exact optimum for the repeated sales problem in the restricted class of strongly monotone contracts- when allocative distortions are monotone in a whole vector of buyer's valuations;iii.the optimum for the repeated sales problem in the unrestricted class of contracts is shown to be backloaded and a theoretical bound is provided for the fraction of optimal revenue that can be extracted by optioning forwards.Finally, the construction of dynamic pricing mechanism and bounds is ported to study repeated auctions.
Book Synopsis Optimal Dynamic Contracting by : Marco Battaglini
Download or read book Optimal Dynamic Contracting written by Marco Battaglini and published by . This book was released on 2015 with total page 50 pages. Available in PDF, EPUB and Kindle. Book excerpt: We study a dynamic principal-agent model in which the agent's types are serially correlated. In these models, the standard approach consists of first solving a relaxed version in which only local incentive compatibility constraints are considered, and then in proving that the local constraints are sufficient for implementability. We explore the conditions under which this approach is valid and can be used to characterize the profit maximizing contract. We show that the approach works when the optimal allocation in the relaxed problem is monotonic in the types, a condition that is satisfied in most solved examples. Contrary to the static model, however, monotonicity is generally violated in many interesting economic environments. Moreover, when the time horizon is long enough and serial correlation is sufficiently high, global incentive compatibility constraints are generically binding. By fully characterizing a simple two period example, we uncover a number of interesting features of the optimal contract that cannot be observed in spatial environments in which the standard approach works. Finally, we show that even in complex environments, approximately optimal allocations can be easily characterized by focusing on a particular class of contracts in which the allocation is forced to be monotonic.
Book Synopsis Understanding the Use of Long-term Finance in Developing Economies by : Mr.Maria Soledad Martinez Peria
Download or read book Understanding the Use of Long-term Finance in Developing Economies written by Mr.Maria Soledad Martinez Peria and published by International Monetary Fund. This book was released on 2017-04-26 with total page 28 pages. Available in PDF, EPUB and Kindle. Book excerpt: This short paper reviews recent literature on the use of long-term finance in developing economies (relative to advanced ones) to identify where long-term financing occurs, and what role different financial intermediaries and markets play in extending this type of financing. Although banks are the most important providers of credit, they do not seem to offer long-term financing. Capital markets have grown since the 1990s and can provide financing at fairly long terms. But few firms use these markets. Only some institutional investors provide funding at long-term maturities. Governments might help to expand long-term financing, although with limited policy tools.
Book Synopsis Financial Contracting When Rivals May Turn Nasty by : Franz Hubert
Download or read book Financial Contracting When Rivals May Turn Nasty written by Franz Hubert and published by . This book was released on 2003 with total page 28 pages. Available in PDF, EPUB and Kindle. Book excerpt: This paper develops a principal--agent model of financial contractingin which optimal contracts resemble a combination of debt and equity. When defaulting on debt, the firm is punished by disruption of external funding. Such contracts however, invite rivals to compete more aggressively to increase the likelihood of default. The firm will respond to the threat of predation, by choosing a less leveraged capital structure, even though this will aggravate incentive problems. In contrast to the literature on debt as a device of strategic commitment, this result supports the common presumption that equity can enhance the firm's competitiveness in the product market.
Book Synopsis Asymmetric Information, Corporate Finance, and Investment by : R. Glenn Hubbard
Download or read book Asymmetric Information, Corporate Finance, and Investment written by R. Glenn Hubbard and published by University of Chicago Press. This book was released on 2009-05-15 with total page 354 pages. Available in PDF, EPUB and Kindle. Book excerpt: In this volume, specialists from traditionally separate areas in economics and finance investigate issues at the conjunction of their fields. They argue that financial decisions of the firm can affect real economic activity—and this is true for enough firms and consumers to have significant aggregate economic effects. They demonstrate that important differences—asymmetries—in access to information between "borrowers" and "lenders" ("insiders" and "outsiders") in financial transactions affect investment decisions of firms and the organization of financial markets. The original research emphasizes the role of information problems in explaining empirically important links between internal finance and investment, as well as their role in accounting for observed variations in mechanisms for corporate control.
Book Synopsis Three Essays on Financial Contracts by : Diego García
Download or read book Three Essays on Financial Contracts written by Diego García and published by . This book was released on 2000 with total page 284 pages. Available in PDF, EPUB and Kindle. Book excerpt:
Book Synopsis Financial Contracting at the Boundary of a Firm by : Maciej Firla Cuchra
Download or read book Financial Contracting at the Boundary of a Firm written by Maciej Firla Cuchra and published by . This book was released on 2004 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: We look at financial contracts determining boundaries of a firm. In the spirit of the incomplete contract theory, we construct a simple model to analyze the optimal allocations of control in financial contracts involving limits on managerial discretion and legal separation of different groups of assets. The model introduces a game-theoretic framework with uncertainty to consider the interplay between different groups of creditors and managers without recourse to the assumptions of asymmetric information. The results are optimality conditions for different contracts from asset-backed securities through project finance to debt with covenants vis-a-vis a standard debt contract. We also show how such departures of financing contracts into the boundaries of the firm can be welfare enhancing.
Book Synopsis Optimal Financial Contracts in a Two Sector Open Economy (Ricardo Meets the CAPM) by : Ronald M. Schramm
Download or read book Optimal Financial Contracts in a Two Sector Open Economy (Ricardo Meets the CAPM) written by Ronald M. Schramm and published by . This book was released on 1996 with total page 38 pages. Available in PDF, EPUB and Kindle. Book excerpt:
