Investment and financing decisions under optimal long-term contracting
GAN Liu
YANG Zhao-jun
Abstract：One important source of financial market frictions involves agency problems which can distort investment and financing decisions. In this paper we develop a dynamic principal-agent model which is based on expand investment and debt financing. Firstly, we consider an optimal contract design problem that assumes unobservable effort and savings of agent. Stochastic differential equation of the agent’s continuation value function is provided by using martingale method. Then we obtain a necessary and sufficient condition for the equilibrium evolution of agent’s value function when contract is incentive compatible. Furthermore, this paper gets the differential equation for the enterprise value where the solution of contracting and optimal level of investment trigger can be obtained at the same time. Finally, we show and explain the different results of optimal effort policy with the corporate cash flow changes under different financing situation. The relationships between the investment trigger level (enterprise value) and the related coefficients are also discussed.
Keywords：optimal long-term contractingrisk aversionoptimal controlgeometric Brownian motioninvestment and financing decisions
Publication Date：2016-01-01
Online Publishing Date：2025-08-15(First online date of this platform, not the publication date of the document)
Pages：9( 1483-1491 )