Renegotiation and the Impossibility of Optimal Investment

John C. Persons

68 citations0/0 files storedReview of Financial Studies

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Corporate Finance and Governance Capital Investment and Risk Analysis Private Equity and Venture Capital

Abstract

In a model with asymmetric information and external equity financing, it is impossible to achieve socially optimal investment because of renegotiation possibilities. The contractual solution suggested by Dybvig and Zender (1991) is not dynamically consistent--the manager's contract would be renegotiated, resulting in inefficient investment. Moreover, no other compensation contract that would induce the manager to invest efficiently survives renegotiation. Contracts that pay the manager based on the stock price, while producing suboptimal investment as in Myers and Majluf (1984), are robust to renegotiation. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

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References

1984Corporate financing and investment decisions when firms have information that investors do not have 1977Determinants of corporate borrowing 1977The Determination of Financial Structure: The Incentive-Signalling Approach 1985Dividend Policy under Asymmetric Information 1986The Folk Theorem in Repeated Games with Discounting or with Incomplete Information 1992An Incomplete Contracts Approach to Financial Contracting 1979Incentive Compatibility and the Bargaining Problem 1988Incomplete Contracts and Renegotiation

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