Anticipating Disagreement in Dynamic Contracting. (2nd February 2022)

• Record Type: Journal Article
• Authors: Zhu, John Y
• Editors: Parlour, Christine
• Is Part Of: Review of finance. Volume 26:Number 5(2022)
• Page Start: 1241
• Page End: 1265
• Publication Date: 2022-02-02
• Subjects: D86 -- G32 -- G33 -- G10; Disagreement -- Uncertainty -- Ambiguity -- Robustness -- Debt -- Overconfidence -- Overinvestment -- Refinance -- Renegotiation -- Equity premium -- Debt-to-equity ratio -- Security design -- Financial contracting -- Optimal contracting; Finance -- Europe -- Periodicals; Financiën; Finance; Periodicals; 332.09405
• DOI: 10.1093/rof/rfac007
• Languages: English
• ISSNs: 1572-3097

Abstract

Abstract: This paper studies how anticipated disagreement between a financier and an entrepreneur affects optimal contracting and asset prices. The value of debt is uniquely immune to anticipated disagreement, and when the set of anticipated disagreements is sufficiently rich, this immunity causes the optimal contract to give the financier debt. In contrast, the values of other contracts, including equity, decline as anticipated disagreement becomes more severe. This suggests a channel through which an increase in the severity of anticipated disagreement increases the equity premium and the debt-to-equity ratio.