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Working Paper

Debt and Equity as Optimal Contracts

The model presented in this paper is a particular case of the principal-agent problem. An entrepreneur has an investment project whose returns depend on his effort, which is not observable by the financier. After determining the optimal contract that is used to finance such a project, I show that this contract can be replicated by a unique combination of debt and equity, which proves the optimality of these financial instruments.

Suggested Citation

Santos, João Cabral dos. 1995. “Debt and Equity as Optimal Contracts.” Federal Reserve Bank of Cleveland, Working Paper No. 95-05.