Financial Contracting at the Boundary of a Firm
Posted: 19 Aug 2004
Date Written: August 2004
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.
Keywords: securitizations, asset-backed securities, contracts, project finance
JEL Classification: G15, G21, G32, G33
Suggested Citation: Suggested Citation