Risk Aversion, Managerial Reputation, and Debt–Equity Conflict
Abstract
:1. Introduction
2. The Model
2.1. Technology and Information
2.2. Entrepreneurial Economy Model
2.3. Corporate Economy Model
- The firm offers the manager a one-period, fixed-wage compensation contract . Such wage can depend on the manager’s observed characteristics (new, old good, or old bad), and it must be feasible in the sense that the firm’s cash flow from the safe project should be sufficient to cover the wage and the face value of debt;
- Creditors lend USD 1 to the firm with a face value of debt that can depend on the manager’s observed characteristics;
- The firm offers the manager to renegotiate their fixed-wage contract for a new contract in which the manager receives all the claims to the firm’s residual cash flow after repaying the debt and a fixed fee to the current shareholders, i.e., a contract , where is the project’s cash flow, is the face value of debt, and is a constant. Such renegotiation consists of the firm making the manager a take-it-or-leave-it offer;
- The manager either accepts the new incentive contract or keeps the original fixed wage contract;
- The manager chooses the project to implement;
- The project’s cash flow is realized and paid out;
- It is observed whether the firm went into bankruptcy (i.e., whether the project’s cash flow was insufficient to cover the debt obligations);
- Current old managers leave the labor market, current new managers proceed to the next period, and a set of new managers enter the labor market.
3. Equilibrium Analysis and Results
- If, then there is a unique pooling equilibrium in which all new managers chose safe projects;
- If, then there is a unique separating equilibrium in which all new risk-neutral managers chose risky projects;
- If, then there are three equilibria: pooling, separating, and a mixed-strategy equilibrium in whichis the share of new risk-neutral managers choosing risky projects. Furthermore, the mixed-strategy equilibrium is unstable in the sense that, given an equilibrium, for any, new risk-neutral managers will prefer to invest in risky projects, while for any, new risk-neutral managers will prefer to invest in safe projects.
4. Conclusions
Funding
Institutional Review Board Statement
Informed Consent Statement
Data Availability Statement
Conflicts of Interest
Appendix A
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Dodonova, A. Risk Aversion, Managerial Reputation, and Debt–Equity Conflict. Games 2022, 13, 25. https://doi.org/10.3390/g13020025
Dodonova A. Risk Aversion, Managerial Reputation, and Debt–Equity Conflict. Games. 2022; 13(2):25. https://doi.org/10.3390/g13020025
Chicago/Turabian StyleDodonova, Anna. 2022. "Risk Aversion, Managerial Reputation, and Debt–Equity Conflict" Games 13, no. 2: 25. https://doi.org/10.3390/g13020025