Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/189906 
Year of Publication: 
2017
Series/Report no.: 
School of Economics Discussion Papers No. 1716
Publisher: 
University of Kent, School of Economics, Canterbury
Abstract: 
We show how the prospect of disputes over firms' revenue reports promotes debt financing over equity. These findings are presented within a costly state verification model with a risk averse entrepreneur. The prospect of disputes encourages incentive contracts that limit penalties and avoid stochastic monitoring, even when the lender can commit to stochastic monitoring strategies. Consequently, optimal contracts shift away from equity and toward standard debt. For a useful special case of the model, closed form solutions are presented for leverage and consumption allocations under efficient debt contracts. Some empirical implications of the theory are pursued.
Subjects: 
Microeconomics
costly state verification
external finance
leverage
JEL: 
D52
D53
D82
D86
Document Type: 
Working Paper

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