Robust leverage dynamics without commitment

Li, Shilin; Yang, Jinqiang; Zhao, Siqi

doi:10.1007/s00199-022-01419-3

Cited by 4 publications

(3 citation statements)

References 71 publications

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“…The optimal contract we obtain is explicit and does not rely on any state variables. This is a key finding that completely differentiates our model from the models above and that is different from the Optimal contracting results of traditional research, such as Cvitani c et al (2013), Krasikov and Lamba (2021) and Li et al (2022), where the solutions of these models are implicit and depend on additional state variables.…”

Section: Related Literaturecontrasting

confidence: 66%

“…In the existing literature, the standard martingale representation is the most widely used technique for solving continuous-time contracting models (Krasikov and Lamba, 2021;Szydlowski and Yoon, 2022). The solutions to these continuous-time contract design models are typically characterized by Hamilton-Jacobi-Bellman equations, which rely on additional state variables, such as the continuation value in Cvitani c et al ( 2013), agent's information rent (He et al, 2017) and discounted penalty (Li et al, 2022). In our study, we develop a methodology for the literature by solving the continuous-time contracting model using a discrete-time approximation approach, in which the project's output depends on the effort choices of both the EN and VC.…”

Section: Introductionmentioning

confidence: 99%

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Optimal contracting with asymmetric belief and complementarity

Chang

Liu

2023

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PurposeIn this study, a dynamic contracting model is developed between a venture capitalist (VC) and an entrepreneur (EN) to explore the influence of asymmetric beliefs regarding output-relevant parameters, agency conflicts and complementarity on the VC's posterior beliefs through the EN's unobservable effort choices to influence the optimal dynamic contract.Design/methodology/approachThe authors construct the contracting model by incorporating the VC's effort, which is ignored in most studies. Using backward induction and a discrete-time approximation approach, the authors solve the continuous-time contract design problem, which evolves into a nonlinear ordinary differential equation (ODE).FindingsThe optimal equity share that the VC provides to the EN decreases over time. In accordance with the empirical evidence, the EN's optimistic beliefs regarding the project's profitability positively affect its equity share. However, the interactions between the optimal equity share, project risk and both partners' degrees of risk aversion are not monotonic. Moreover, the authors find that the optimal equity share increases with the degree of complementarity, which indicates that the EN is willing to cooperate with the VC. This study’s results also show that the optimal equity shares at each time are interdependent if the VC is risk-averse and independent if the VC is risk-neutral.Research limitations/implicationsIn conclusion, the authors highlight two potential directions for future research. First, the authors only considered a single VC, whereas in practice, a risk project may be carried out by multiple VCs, and it is interesting to discuss how the degree of complementarity affects the number of VCs that ENs contract. Second, the authors may introduce jumps and consider more general multivariate stochastic volatility models for output dynamics and analyze the characteristics of the optimal contracts. Third, further research can deal with other forms of discretionary output functions concerning complementarity, such as Cobb–Douglas and constant elasticity of substitution (See Varian, 1992).Social implicationsThe results of this study have several implications. First, it offers a novel approach to designing dynamic contracts that are specific and easy to operate. To improve the complicated venture investment situation and abate conflict between contractual parties, this study plays a good reference role. Second, the synergy effect proposed in this study provides a theoretical explanation for the executive compensation puzzle in economics, in which managers are often “rewarded for luck” (Bertrand and Mullainathan, 2001; Wu et al., 2018). This result indicates a realistic perspective on financing and establishing cooperative relationships, which enhances the efficiency of venture investment. Third, from an empirical standpoint, one can apply this framework to study research and development (R&D) problems.Originality/valueFirst, the authors introduce asymmetric beliefs and Bayesian learning to study the dynamic contract design problem and discuss their effects on equity share. Second, the authors incorporate the VC's effort into the contracting problem, and analyze the synergistic effect of effort complementarity on the optimal dynamic contract.

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Section: Related Literaturecontrasting

confidence: 66%

Section: Introductionmentioning

confidence: 99%

Optimal contracting with asymmetric belief and complementarity

Chang

Liu

2023

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“…If the default option is sufficiently in-the-money, ambiguity-averse shareholders are tempted to adopt a more aggressive debt policy because they can transfer model uncertainty to creditors upon default. Li et al (2022) also show that the commitment against future debt dilution could be suboptimal because of inefficient ambiguity sharing. Sung (2022) analyzes a continuous-time principal-agent problem under ambiguity about both the mean and the volatility of a diffusion process.…”

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confidence: 94%

Introduction to the special issue in honor of Larry Epstein

Miao

2022

Econ Theory

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He was elected a Fellow of the Econometric Society in 1989, an Economic Theory Fellow of the Society for the Advancement of Economicy Theory in 2011, and a Member of the American Academy of Arts and Science in 2013, and was awarded the Frisch Medal in 1994.Epstein has made numerous fundamental contributions in microeconomics, decision theory, and mathematical economics. His main research topics focus on how to model individual decision-making under uncertainty. He often adopts an axiomatic approach in abstract models, though always with an eye towards tractability and usefulness for applications, both theoretical and empirical. Besides applications within economics, his work has connections to finance (theoretical and empirical asset pricing), operations research (robust stochastic optimization), probability theory (limit theorems), and statistics (robust inference and hypothesis testing).This special issue contains ten papers contributed by Epstein's former students, coauthors, and fans. These papers are inspired and influenced by Epstein's research. Let me start with the papers related to Epstein's work on ambiguity.Halevy and Ozdenoren (2022) present a theoretical model of decision making in which preferences are defined on both Savage subjective acts and compound objective lotteries. They introduce the concept of two-stage probabilistically sophistication (2SPS), which generalizes the concept of probabilistically sophistication of Machina and Schmeidler (1992). The latter is used as a benchmark for ambiguity neutrality by Epstein (1999). Preferences are 2SPS when the ranking of acts corresponds to a ranking of the respective compound lotteries induced by the acts through the decision maker's subjective belief. This family of preferences includes various theoretical models (e.g., the smooth ambiguity model of Klibanoff et al. (2005)) that have been proposed in the literature to accommodate non-neutral attitude towards ambiguity. The principle B Jianjun Miao

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Robust dynamic contracts with multiple agents

Niu,

Zou

2024

Games and Economic Behavior

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Robust leverage dynamics without commitment

Cited by 4 publications

References 71 publications

Optimal contracting with asymmetric belief and complementarity

Optimal contracting with asymmetric belief and complementarity

Introduction to the special issue in honor of Larry Epstein

Robust dynamic contracts with multiple agents

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