Sep 19, 2017

(MAXIMAL INCENTIVES PRINCIPLE IN THE FIXED-INVESTMENT MODEL). PURSUE THE ANALYSIS OF SECTION…

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(maximal incentives principle in the fixed-investment model). Pursue the analysis of Section 3.4.3, but for the fixed-investment model of Section 3.2: the investment cost I is given and the income is either RS or RF (instead of R or 0), where RS > RF > 0. We assume that

so the project cannot be straightforwardly financed by bringing in net worth A and pledging the lower income RF to lenders. Let

denote the increase in income from the low to the high level. Show that the debt contract is optimal, but unlike in the variable-investment case it may not be uniquely optimal.


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