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Project Financing when the Principal Cannot Commit

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  • M. Martin Boyer

Abstract

Suppose an entrepreneur needs funds from a financier to invest in a risky project whose cost is fixed, and whose return may be high or low. Suppose also that the project's realized return is an information that is private to the entrepreneur. If the amount the entrepreneur pays back to the financier depends on the risky project's outcome, if it is costly for the financier to verify the project's true realized return, and if the financier cannot commit to an auditing strategy, then it is optimal for the entrepreneur to misreport the true state of the world with some probability. In other words, it is in the entrepreneur's interest to lie with a degree of probability. We find that the entrepreneur over-finances his project when the financier cannot commit, and that he has greater wealth ex post if the project is not successful. Over-borrowing and greater wealth in the low-return state result in reducing the number of false reports in the economy. Prenons une économie où un entrepreneur a besoin de financement afin d'entreprendre un projet risqué dont le coût est fixe et dont le rendement peut être faible ou élevé. Supposons alors que ce rendement est une information privée de l'entrepreneur. Si le montant que l'entrepreneur doit rembourser au financier dépend du rendement sur le projet risqué, s'il est coûteux pour le financier de vérifier le rendement réel du projet, et si le financier ne peut se commettre en une stratégie de vérification, alors il devient optimal pour l'entrepreneur de ne pas dire la vérité tout le temps. Nous trouvons premièrement que l'entrepreneur sur-finance son projet d'investissement si le financier ne peut se commettre, et deuxièmement que l'entrepreneur a une plus grande richesse ex post si le projet ne porte pas fruit. Ce sur-financement et cette plus grande richesse dans le mauvais état de la nature sont le produit de l'absence d'engagement de la part du principal qui doit utiliser ces signaux coûteux afin de réduire le nombre de faux messages dans l'économie.

Suggested Citation

  • M. Martin Boyer, 2001. "Project Financing when the Principal Cannot Commit," CIRANO Working Papers 2001s-29, CIRANO.
    • Handle: RePEc:cir:cirwor:2001s-29
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    References listed on IDEAS

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    Cited by:

    1. Karel Janda, 2004. "Bankruptcy Procedures with Ex Post Moral Hazard," Working Papers IES 61, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised 2004.
    2. Karel Janda, 2007. "Optimal Debt Contracts in Emerging Markets with Multiple Investors," Prague Economic Papers, Prague University of Economics and Business, vol. 2007(2), pages 115-129.

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    More about this item

    Keywords

    Commitment; financing; asymmetric information; ex post moral hazard; Engagement; financement; information asymétrique; aléa moral ex post;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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