Dynamic Financial Contracting with Persistent Private Information with R. Vijay Krishna (web Appendix)
RAND Journal of Economics, 2019, Vol.50 No. 2, pp. 418-452.
Voluntary Disclosure, Moral Hazard, and Default Risk with Giulio Trigilia
Management Science, 2023, published online.
Experimenting to Finance with Shuguang Zhu (Under Review)
We examine the interplay between experimentation and security design in a staged financing setting with costly verification of cash flows. An entrepreneur first designs and raises capital to conduct an experiment whose outcomes determine whether financing continues and, if so, how it is structured. The optimal experiment improves investment efficiency by identifying a financing milestone below which projects are abandoned and by lowering default probability. It also endogenously gives rise to participating preferred equity and venture debt with warrants. The model predicts that ventures founded by less experienced entrepreneurs or requiring larger experimentation investments are more likely to be financed through participating preferred equity. It further predicts that higher experimentation or verification costs may leave venture value unchanged or even increase it by inducing a more restrictive financing milestone and higher venture success rates.
Dynamic Capital Allocation, Incentive, and Monitoring (Revising)
This paper studies dynamic capital budgeting when project information is privately known by the division manager who benefits from inefficiently deploying capital. Performance history endogenously determines the budget size which affects the incentive versus monitoring trade-off in different projects. When the budget is small, cash incentive is costly, investment is severely rigid, and monitoring focuses on large projects. When the budget becomes larger, investment is less rigid and monitoring shifts toward smaller projects. When the budget is sufficiently large, steep incentives are provided to induce efficient investments and no project is monitored. The model better explains the evidences that firm stored liquidity is positively correlated with incentive pay, and negatively with investment hurdle rates. It also predicts new and endogenous monitoring strategies in capital budgeting.