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Optimal financial contracting and the effects of firm's size
Author(s) -
Brusco Sandro,
Lopomo Giuseppe,
Ropero Eva,
Villa Alessandro T.
Publication year - 2021
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 - 10.1111/1756-2171.12375
Subject(s) - economics , moral hazard , capital (architecture) , capital structure , econometrics , variable (mathematics) , hazard , interest rate , monetary economics , microeconomics , finance , mathematics , incentive , debt , mathematical analysis , chemistry , archaeology , organic chemistry , history
We consider the design of the optimal dynamic policy for a firm subject to moral hazard problems. With respect to the existing literature we enrich the model by introducing durable capital with partial irreversibility, which makes the size of the firm a state variable. This allows us to analyze the role of firm's size, separately from age and financial structure. We show that a higher level of capital decreases the probability of liquidation and increases the future size of the firm. Although analytical results are not available, we show through simulations that, conditional on size, the rate of growth of the firm, its variability, and the variability of the probability of liquidation decline with age.