IDEAS home Printed from https://ideas.repec.org/a/oup/revfin/v26y2022i5p1241-1265..html
   My bibliography  Save this article

Anticipating Disagreement in Dynamic Contracting
[An incomplete contracts approach to financial contracting]

Author

Listed:
  • John Y Zhu

Abstract

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.

Suggested Citation

  • John Y Zhu, 2022. "Anticipating Disagreement in Dynamic Contracting [An incomplete contracts approach to financial contracting]," Review of Finance, European Finance Association, vol. 26(5), pages 1241-1265.
    • Handle: RePEc:oup:revfin:v:26:y:2022:i:5:p:1241-1265.
    as

    Download full text from publisher

    File URL: http://hdl.handle.net/10.1093/rof/rfac007
    Download Restriction: Access to full text is restricted to subscribers.
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Sujoy Mukerji & Jean-Marc Tallon, 2005. "Ambiguity aversion and the absence of indexed debt," Studies in Economic Theory, in: Alessandro Citanna & John Donaldson & Herakles Polemarchakis & Paolo Siconolfi & Stephan E. Spear (ed.), Essays in Dynamic General Equilibrium Theory, pages 143-179, Springer.
    2. Ulrike Malmendier & Geoffrey Tate, 2005. "CEO Overconfidence and Corporate Investment," Journal of Finance, American Finance Association, vol. 60(6), pages 2661-2700, December.
    3. Huang, Sheng & Maharjan, Johan & Thakor, Anjan V., 2020. "Disagreement-induced CEO turnover," Journal of Financial Intermediation, Elsevier, vol. 43(C).
    4. Dai, Na & Ivanov, Vladimir & Cole, Rebel A., 2017. "Entrepreneurial optimism, credit availability, and cost of financing: Evidence from U.S. small businesses," Journal of Corporate Finance, Elsevier, vol. 44(C), pages 289-307.
    5. repec:bla:jfinan:v:43:y:1988:i:2:p:507-28 is not listed on IDEAS
    6. Douglas W. Diamond, 1984. "Financial Intermediation and Delegated Monitoring," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 51(3), pages 393-414.
    7. John Geanakoplos, 2009. "The Leverage Cycle," Cowles Foundation Discussion Papers 1715R, Cowles Foundation for Research in Economics, Yale University, revised Jan 2010.
    8. Philippe Aghion & Patrick Bolton, 1992. "An Incomplete Contracts Approach to Financial Contracting," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 59(3), pages 473-494.
    9. Alp Simsek, 2013. "Belief Disagreements and Collateral Constraints," Econometrica, Econometric Society, vol. 81(1), pages 1-53, January.
    10. Higashide, Hironori & Birley, Sue, 2002. "The consequences of conflict between the venture capitalist and the entrepreneurial team in the United Kingdom from the perspective of the venture capitalist," Journal of Business Venturing, Elsevier, vol. 17(1), pages 59-81, January.
    11. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
    12. Douglas Gale & Martin Hellwig, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 52(4), pages 647-663.
    13. Arnoud W. A. Boot & Anjan V. Thakor, 2011. "Managerial Autonomy, Allocation of Control Rights, and Optimal Capital Structure," The Review of Financial Studies, Society for Financial Studies, vol. 24(10), pages 3434-3485.
    14. Eric Van den Steen, 2010. "Interpersonal Authority in a Theory of the Firm," American Economic Review, American Economic Association, vol. 100(1), pages 466-490, March.
    15. Thakor, Anjan V., 2015. "Strategic information disclosure when there is fundamental disagreement," Journal of Financial Intermediation, Elsevier, vol. 24(2), pages 131-153.
    16. Augustin Landier & David Thesmar, 2009. "Financial Contracting with Optimistic Entrepreneurs," The Review of Financial Studies, Society for Financial Studies, vol. 22(1), pages 117-150, January.
    17. John Geanakoplos, 2010. "The Leverage Cycle," NBER Chapters, in: NBER Macroeconomics Annual 2009, Volume 24, pages 1-65, National Bureau of Economic Research, Inc.
    18. Gabriel Carroll, 2015. "Robustness and Linear Contracts," American Economic Review, American Economic Association, vol. 105(2), pages 536-563, February.
    19. Nachman, David C & Noe, Thomas H, 1994. "Optimal Design of Securities under Asymmetric Information," The Review of Financial Studies, Society for Financial Studies, vol. 7(1), pages 1-44.
    20. J. Michael Harrison & David M. Kreps, 1978. "Speculative Investor Behavior in a Stock Market with Heterogeneous Expectations," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 92(2), pages 323-336.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Brunnermeier, Markus K. & Oehmke, Martin, 2013. "Bubbles, Financial Crises, and Systemic Risk," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 1221-1288, Elsevier.
    2. repec:hal:spmain:info:hdl:2441/293qice3lj861rvos9ns14n0h0 is not listed on IDEAS
    3. Committee, Nobel Prize, 2022. "Financial Intermediation and the Economy," Nobel Prize in Economics documents 2022-2, Nobel Prize Committee.
    4. repec:spo:wpmain:info:hdl:2441/293qice3lj861rvos9ns14n0h0 is not listed on IDEAS
    5. Tan, Liang, 2013. "Creditor control rights, state of nature verification, and financial reporting conservatism," Journal of Accounting and Economics, Elsevier, vol. 55(1), pages 1-22.
    6. Kondor, Péter & Köszegi, Botond, 2015. "Cursed financial innovation," Discussion Papers, Research Unit: Economics of Change SP II 2015-306, WZB Berlin Social Science Center.
    7. Stenzel, André, 2018. "Security design with interim public information," Journal of Mathematical Economics, Elsevier, vol. 76(C), pages 113-130.
    8. Gersbach, Hans & Uhlig, Harald, 2006. "Debt contracts and collapse as competition phenomena," Journal of Financial Intermediation, Elsevier, vol. 15(4), pages 556-574, October.
    9. Langberg, Nisan, 2008. "Optimal financing for growth firms," Journal of Financial Intermediation, Elsevier, vol. 17(3), pages 379-406, July.
    10. Meradj Morteza Pouraghdam, 2016. "Three essays on the role of frictions in the economy [Trois essais sur le rôle du désaccord en économie]," SciencePo Working papers Main tel-03498781, HAL.
    11. Saki Bigio & Eduardo Zilberman, 2020. "Speculation-Driven Business Cycles," Working Papers Central Bank of Chile 865, Central Bank of Chile.
    12. V. Bhaskar & Caroline Thomas, 2019. "The Culture of Overconfidence," American Economic Review: Insights, American Economic Association, vol. 1(1), pages 95-110, June.
    13. Ricardo J. Caballero & Alp Simsek, 2019. "Prudential Monetary Policy," NBER Working Papers 25977, National Bureau of Economic Research, Inc.
    14. Andrea Ajello & Nina Boyarchenko & François Gourio & Andrea Tambalotti, 2022. "Financial Stability Considerations for Monetary Policy: Theoretical Mechanisms," Staff Reports 1002, Federal Reserve Bank of New York.
    15. Ricardo J Caballero & Alp Simsek, 2020. "A Risk-Centric Model of Demand Recessions and Speculation," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 135(3), pages 1493-1566.
    16. Choi, Dong Beom & Eisenbach, Thomas M. & Yorulmazer, Tanju, 2021. "Watering a lemon tree: Heterogeneous risk taking and monetary policy transmission," Journal of Financial Intermediation, Elsevier, vol. 47(C).
    17. R. Anton Braun & Tomoyuki Nakajima, 2018. "Why Prices Don't Respond Sooner to a Prospective Sovereign Debt Crisis," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 29, pages 235-255, July.
    18. Angeletos, G.-M. & Lian, C., 2016. "Incomplete Information in Macroeconomics," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 1065-1240, Elsevier.
    19. Huang, Sheng & Maharjan, Johan & Thakor, Anjan V., 2020. "Disagreement-induced CEO turnover," Journal of Financial Intermediation, Elsevier, vol. 43(C).
    20. Markus K. Brunnermeier & Thomas M. Eisenbach & Yuliy Sannikov, 2012. "Macroeconomics with Financial Frictions: A Survey," Levine's Working Paper Archive 786969000000000384, David K. Levine.
    21. Felipe S. Iachan & Plamen T. Nenov & Alp Simsek, 2021. "The Choice Channel of Financial Innovation," American Economic Journal: Macroeconomics, American Economic Association, vol. 13(2), pages 333-372, April.
    22. Hitoshi Matsushima, 2013. "Role of Credit Default Swap in Bubbles and Crashes," CARF F-Series CARF-F-331, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.

    More about this item

    Keywords

    Disagreement; Uncertainty; Ambiguity; Robustness; Debt; Overconfidence; Overinvestment; Refinance; Renegotiation; Equity premium; Debt-to-equity ratio; Security design; Financial contracting; Optimal contracting;
    All these keywords.

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:oup:revfin:v:26:y:2022:i:5:p:1241-1265.. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Oxford University Press (email available below). General contact details of provider: https://edirc.repec.org/data/eufaaea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.