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Title:A theory of firm decline PDF Logo
Authors:Clementi, Gian Luca
Cooley, Thomas F.
Di Giannatale, Sonia
Issue Date:2010
Series/Report no.:Nota di lavoro // Fondazione Eni Enrico Mattei: Institutions and markets 2010,88
Abstract:We study the problem of an investor that buys an equity stake in an entrepreneurial venture, under the assumption that the former cannot monitor the latter's operations. The dynamics implied by the optimal incentive scheme is rich and quite different from that induced by other models of repeated moral hazard. In particular, our framework generates a rationale for firm decline. As young firms accumulate capital, the claims of both investor (outside equity) and entrepreneur (inside equity) increase. At some juncture, however, even as the latter keeps on growing, invested capital and firm value start declining and so does the value of outside equity. The reason is that incentive provision is costlier the wealthier the entrepreneur (the greater is inside equity). In turn, this leads to a decline in the constrained-efficient level of effort and therefore to a drop in the return to investment.
Subjects:Principal Agent
Moral Hazard
Hidden Action
Incentives
Survival
Firm Dynamics
JEL:D82
D86
D92
G32
Document Type:Working Paper
Appears in Collections:FEEM Working Papers, Fondazione Eni Enrico Mattei

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