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.
Working Papers of the Federal Reserve Bank of Cleveland are preliminary materials circulated to stimulate discussion and critical comment on research in progress. They may not have been subject to the formal editorial review accorded official Federal Reserve Bank of Cleveland publications. The views expressed in this paper are those of the authors and do not represent the views of the Federal Reserve Bank of Cleveland or the Federal Reserve System.
Suggested Citation
Santos, João Cabral dos. 1995. “Debt and Equity as Optimal Contracts.” Federal Reserve Bank of Cleveland, Working Paper No. 95-05. https://doi.org/10.26509/frbc-wp-199505
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