Sep 19, 2017


This paper concentrates on the primary theme of (LENDER MARKET POWER). (I) FIXED INVESTMENT. AN ENTREPRENEUR HAS CASH AMOUNT A AND WANTS TO… in which you have to explain and evaluate its intricate aspects in detail. In addition to this, this paper has been reviewed and purchased by most of the students hence; it has been rated 4.8 points on the scale of 5 points. Besides, the price of this paper starts from £ 40. For more details and full access to the paper, please refer to the site.

(lender market power). (i) Fixed investment. An entrepreneur has cash amount A and wants to invest I>A into a (fixed-size) project. The project yields R > 0 with probability p and 0 with probability 1 − p. The probability of success is pH if the entrepreneur works and pL = pH − ∆p (∆p > 0) if she shirks. The entrepreneur obtains private benefit B if she shirks and 0 otherwise. The borrower is protected by limited liability and everyone is risk neutral. The project is worthwhile only if the entrepreneur behaves. There is a single lender. This lender has access to funds that command an expected rate of return equal to 0 (so the lender would content himself with a 0 rate of return, but he will use his market power to obtain a superior rate of return). Assume

and let A and Aˆ be defined by

Assume that A > 0 and that the lender makes a take-it-or-leave-it offer to the borrower (i.e., the lender chooses Rb, the borrower’s compensation in the case of success). • What contract is optimal for the lender? • Is the financing decision affected by lender market power (i.e., compared with the case of competitive lenders solved in Section 3.2)? • Draw the borrower’s net utility (i.e., net of A) as a function of A and note that it is nonmonotonic (distinguish four regions: (−∞, A), [A, ˆA)ˆ , [A, I) ˆ , [I, ∞)). Explain.

(ii) Variable investment. Answer the first two bullets in question (i) (lender’s optimal contract and impact of lender market power on the investment decision) in the variable-investment version. In particular, show that lender market power reduces the scale of investment. (Reminder: I is chosen in [0, ∞). The project yields RI if successful and 0 if it fails. Shirking, which reduces the probability of success from pH to pL, yields private benefit BI. Assume that pHR > 1 > pH(R − B/∆p). Hint: show that the two constraints in the lender’s program are binding.)

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