Financing and corporate growth under repeated moral hazard

We develop an incomplete contracts model to study the extent to which control rights of different financings affect corporate growth. The model admits a standard hold-up problem under equity financing; insiders may be disincentivized to do R&D because outside investors can use their control rights to expropriate large parts of the returns by hiring more efficient managers in the future. Debt financing may give rise to a double moral hazard problem; both managers and shareholders may divert corporate resources to themselves before debt is serviced. However, in many cases, these phenomena do not occur in equilibrium and control rights are irrelevant. Cross-sectional predictions are derived from those cases where control rights matter. Consistent with the empirical evidence, leverage is inversely related to growth and to profitability.