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Leverage and Risk Taking

Author

Listed:
  • Santiago Moreno-BROMBERG

    (University of Zurich - Department of Banking and Finance)

  • Guillaume ROGER

    (University of Sydney - School of Economics)

Abstract

We study a dynamic contracting problem in which size is relevant. The agent may take on excessive risk to enhance short-term gains, which exposes the principal to large, infrequent losses. To preserve incentive compatibility, the optimal contract uses size as an instrument; there is downsizing on the equilibrium path. The contract may be implemented using the full array of financial securities or as a regulation contract with a leverage ratio. We show that holding equity is essential to curb risk taking. Firms that are less prone to risk taking can afford a higher leverage.

Suggested Citation

  • Santiago Moreno-BROMBERG & Guillaume ROGER, 2015. "Leverage and Risk Taking," Swiss Finance Institute Research Paper Series 15-64, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1564
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    Cited by:

    1. Tak-Yuen Wong, 2019. "Dynamic Agency and Endogenous Risk-Taking," Management Science, INFORMS, vol. 65(9), pages 4032-4048, September.
    2. Felix Feng, 2018. "Dynamic Compensation under Uncertainty Shocks and Limited Commitment," 2018 Meeting Papers 159, Society for Economic Dynamics.

    More about this item

    Keywords

    asymmetric information; dynamic contracts; moral hazard; risk taking;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • L43 - Industrial Organization - - Antitrust Issues and Policies - - - Legal Monopolies and Regulation or Deregulation

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