Anticipating Disagreement in Dynamic Contracting | Zendy

John Y. Zhu | Zendy

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Anticipating Disagreement in Dynamic Contracting

Author(s) -

John Y. Zhu

Publication year - 2022

Publication title -

review of finance

Language(s) - English

Resource type - Journals

SCImago Journal Rank - 4.933

H-Index - 61

eISSN - 1875-824X

pISSN - 1572-3097

DOI - 10.1093/rof/rfac007

Subject(s) - economics , equity (law) , debt , monetary economics , asset (computer security) , value (mathematics) , financial economics , microeconomics , finance , computer security , machine learning , political science , computer science , law

This paper studies how anticipated disagreement between a financier and an entrepreneur affects optimal contracting and asset prices. The value of debt is uniquely immune to anticipated disagreement, and when the set of anticipated disagreements is sufficiently rich, this immunity causes the optimal contract to give the financier debt. In contrast, the values of other contracts, including equity, decline as anticipated disagreement becomes more severe. This suggests a channel through which an increase in the severity of anticipated disagreement increases the equity premium and the debt-to-equity ratio.

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