Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/217070
Authors: 
Duncan, Alfred J. M.
Nolan, Charles
Year of Publication: 
2019
Citation: 
[Journal:] Theoretical Economics [ISSN:] 1555-7561 [Volume:] 14 [Year:] 2019 [Issue:] 3 [Pages:] 887-925
Abstract: 
We show how the prospect of disputes over firms' revenue reports promotes debt financing over equity. This is demonstrated in 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. Consequently, optimal contracts shift from equity toward standard debt. In short: When audit signals are weakly correlated with true incomes, standard debt contracts emerge as optimal; if audit signals are highly correlated with true incomes, optimal contracts resemble equity. When audit costs are sufficiently high, stochastic monitoring may be optimal. Optimal standard debt contracts under imperfect audits are shown to reproduce key empirical facts of US firm borrowing.
Subjects: 
Microeconomics
costly state veri&#xfb01
cation
external &#xfb01
nance
leverage
JEL: 
D52
D53
D82
D86
Persistent Identifier of the first edition: 
Creative Commons License: 
https://creativecommons.org/licenses/by-nc/4.0/
Document Type: 
Article

Files in This Item:
File
Size





Items in EconStor are protected by copyright, with all rights reserved, unless otherwise indicated.