A Theory of Firm Decline / Gian Luca Clementi, Thomas F. Cooley, Sonia Di Giannatale.

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Clementi, Gian Luca

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Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w15192.Publication details: Cambridge, Mass. National Bureau of Economic Research 2009.Description: 1 online resource: illustrations (black and white)Subject(s):

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Abstract: We study the problem of an investor who 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.

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Item type	Home library	Collection	Call number	Status	Date due	Barcode	Item holds
Working Paper	Biblioteca Digital	Colección NBER	nber w15192 (Browse shelf(Opens below))	Not For Loan

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July 2009.

We study the problem of an investor who 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.