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Dynamic financial contracting with persistent private information
Author(s) -
Fu Shiming,
Krishna R. Vijay
Publication year - 2019
Publication title -
the rand journal of economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 3.687
H-Index - 108
eISSN - 1756-2171
pISSN - 0741-6261
DOI - 10.1111/1756-2171.12275
Subject(s) - private information retrieval , incentive , stock (firearms) , business , principal–agent problem , agency (philosophy) , finance , monetary economics , agency cost , cash , information asymmetry , economics , microeconomics , corporate governance , shareholder , computer science , mechanical engineering , computer security , philosophy , epistemology , engineering
We study a dynamic agency model where the agent privately observes the firm's cash flows that are subject to persistent shocks. We characterize the policy dynamics and implement the optimal contract by financial securities. Because bad performance distorts investors' beliefs downward, the agent has less incentive to misrepresent information. The agent's compensation is less than what he can divert and is convex in performance. As private information becomes more persistent, (i) the agent is compensated more by stock options; (ii) firm credit limits vary more with history, dropping after bad performance; (iii) the firm is financially constrained for longer time.