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Optimality of Investment under Imperfectly Enforceable Financial Contracts
Author(s) -
Chu HsiaoLei,
Chen NanKuang
Publication year - 2003
Publication title -
economic inquiry
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.823
H-Index - 72
eISSN - 1465-7295
pISSN - 0095-2583
DOI - 10.1093/ei/cbg011
Subject(s) - economics , investment (military) , subsidy , debt , monetary economics , welfare , capital (architecture) , finance , microeconomics , market economy , archaeology , politics , political science , law , history
We investigate the optimality of aggregate investment and its policy implications under an environment in which financial contracts are imperfectly enforceable. We show that too much investment occurs when the ratio of own capital to debt is smaller than the ratio of project returns in terms of future values across periods, and too low investment occurs otherwise. A subsidy (tax) on the risk‐free interest income can close the over‐ (under‐) investment gap, but this policy may not be welfare improving.