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Technology choice bias and limited liability

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  • Norman Ireland

Abstract

The effect of limited liability on debt contracts has been analysed as creating the possibility of credit rationing and hence inefficiently low levels of investment. In this paper we instead focus on restrictions on the use of debt finance to avoid moral hazard problems but which add inefficiency by removing management discretion in the investment process. Essentially, the trade-off is between “rules” and “discretion”, and can lead to the wrong choice of technology being adopted. It is shown that this inefficient technology can persist in a steady-state competitive equilibrium. The role of venture capitalists is to reduce this inefficiency both by providing equity rather than debt finance and by involvement in the firm’s management. The latter involvement can counteract other possible agency problems associated with the dilution of the firm’s equity share. Copyright Springer-Verlag Berlin/Heidelberg 2004

Suggested Citation

  • Norman Ireland, 2004. "Technology choice bias and limited liability," Economics of Governance, Springer, vol. 5(2), pages 103-118, July.
    • Handle: RePEc:spr:ecogov:v:5:y:2004:i:2:p:103-118
    DOI: 10.1007/s10101-003-0069-z
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