Abstract

http://ssrn.com/abstract=1159781
 


 



Self-Enforcing Stochastic Monitoring and the Separation of Debt and Equity Claims


Harold L. Cole


University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER)

October 27, 2011

PIER Working Paper No. 08-025

Abstract:     
We study the incentive issues associated with self-enforcing stochastic monitoring in a model of investment and production. The efficient contract features a debt-like payment with a threshold in terms of the reported output in which all of the reported output is taken up to the threshold if monitoring doesn't occur and all of the output is taken if monitoring does occur. An output report above the threshold leads to zero probability of monitoring and just the threshold amount being paid out. The efficiency gap between the self-enforcing contract and the commitment constraint is minimized when the monitors holds no part of the residual claim on the firm, which we associate with equity. Misreporting by the manager is an important component of the efficient
contract.

Number of Pages in PDF File: 51

Keywords: Capital Structure, Monitoring, Incentives, Self-Fulfilling

JEL Classification: G32, D82, D86

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Date posted: November 3, 2011  

Suggested Citation

Cole, Harold L., Self-Enforcing Stochastic Monitoring and the Separation of Debt and Equity Claims (October 27, 2011). PIER Working Paper No. 08-025. Available at SSRN: http://ssrn.com/abstract=1159781 or http://dx.doi.org/10.2139/ssrn.1159781

Contact Information

Harold L. Cole (Contact Author)
University of Pennsylvania - Department of Economics ( email )
3718 Locust Walk
436 McNeil
Philadelphia, PA 19104
United States
215-898-7788 (Phone)
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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