Question

Problems on advanced capital structure theories books

Answer 1

In the model the agent can misreport the firm earnings and transfer money to his own savings account, but there is an optimal contract under which the agent will report truthfully, and will not save, but consume everything heis paid. The model leads to a relatively simple and realistic financing structure, consisting of equity (dividends), long-termdebt and a credit line. These instruments are used for financing the initial capital needed, as well as for the agent’s salary and covering possible operating losses. The agent is paid by a fixed fractionof dividends, which he has control over. At the optimum, the dividends are paid locally, when the agent’s expected utility process hits a certain boundary point, or equivalently, after the credit line balance hasbeen paid off.