Scientific Monographs, Bank of Finland
No E:30/2004:
Essays on financial contracting
Jukka Vauhkonen ()
Abstract: This thesis consists of an introductory chapter and four
essays on financial contracting theory. In the first essay, we argue that
many adverse selection models of standard one-period loan contracts are not
robust to changes in market structure. We argue that debt is not an optimal
contract in these models, if there is only one (monopoly) financier instead
of a large number of competitive financiers.
In the second essay, we
examine the welfare effects of allowing banks to hold equity in their
borrowing firms. According to the agency cost literature, banks’ equity
stakes in their borrowing firms would seem to alleviate firms’ asset
substitution moral hazard problem associated with debt financing. We argue
that this alleged benefit of banks’ equity holding is small or non-existent
when banks are explicitly modelled as active monitors and firms have access
also to market finance.
In the third essay, we extend the well-known
incomplete contracting model of Aghion and Bolton to attempt to explain the
empirical observation that the allocation of control rights between
entrepreneur and venture capitalist is often contingent in the following
way. If the company’s performance (eg earnings before taxes and interest)
is bad, the venture capital firm obtains full control of the company. If
company performance is medium, the entrepreneur retains or obtains more
control rights. If company performance is good, the venture capitalist
relinquishes most of his control rights.
The fourth essay is a short
note, in which we show that the main result of the model of Aghion and
Bolton concerning optimality properties of contingent control allocations
in an incomplete contracting environment holds only if an additional
condition is satisfied.
Keywords: financial contracts; security design; capital structure; incomplete contracts; (follow links to similar papers)
141 pages, December 29, 2004
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