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Financing Constraints and Relational Contracts

Abstract

We consider a model in which a principal must both repay a loan and motivate an agent to work hard. Output is non-contractible, so the principal faces a commitment problem with both her creditor and her agent. In a profit-maximizing equilibrium, the agent's productivity is initially low and increases over time. Productivity continues increasing even after the debt has been repaid, eventually converging to a steady state that is independent of the size of the initial loan. We apply the model to argue that a firm that relies on external debt will typically under-invest in the scale of its existing businesses, but might either over- or under-invest when expanding into new lines of business.

Type

Working Paper

Author(s)

Daniel Barron, Jin Li

Date Published

2016

Citations

Barron, Daniel, and Jin Li. 2016. Financing Constraints and Relational Contracts.

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