Limited Liability and Option Contracts in Models with Sequential Investments

Arbeitspapier

The paper investigates a model where two parties sequentially invest in a joint project (an asset). Investments and the project value are unverifiable, and A is wealth constrained so that an initial outlay must be financed by either agent B or an external investor C, say a bank. We show that an option contract in combination with a loan arrangement facilitates first best investments and any distribution of surplus if renegotiation is infeasible. Moreover, the optimal strike price of the option is shown to differ across financing modes. If renegotiation is admitted, the first best can still be attained unless A's bargaining position is too strong. Otherwise, B financing or C financing may become strictly preferable, and a combination of multiple lenders may be optimal.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Bonn Econ Discussion Papers ; No. 27/2001

Classification and Topics

• Classification: Wirtschaft ; Organizational Behavior; Transaction Costs; Property Rights ; National Government Expenditures and Related Policies: Procurement ; Economics of Regulation
• Subject: Option Contracts ; Corporate Finance ; Sequential Investments ; Double Moral Hazard

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Lülfesmann, Christoph
• Event: Veröffentlichung
• (who): University of Bonn, Bonn Graduate School of Economics (BGSE)
• (where): Bonn
• (when): 2001

Further information

• Handle: http://hdl.handle.net/10419/78386
• Last update: 10.03.2025, 11:42 AM CET