Financing Constraints and Relational Contracts

Research output: Working paper

Abstract

We consider a model in which a principal must both repay a loan and motivate an agent to work hard. Output is non-contractible, so the principal faces a commitment problem with both her creditor and her agent. In a profit-maximizing equilibrium, the agent's productivity is initially low and increases over time. Productivity continues increasing even after the debt has been repaid, eventually converging to a steady state that is independent of the size of the initial loan. We apply the model to argue that a firm that relies on external debt will typically
under-invest in the scale of its existing businesses, but might either over- or under-invest when expanding into new lines of business.
Original languageEnglish (US)
Number of pages35
StatePublished - Aug 14 2015

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