TY  - JOUR
AU  - Clementi,Gian Luca
AU  - Cooley,Thomas F.
AU  - Giannatale,Sonia Di
TI  - A Theory of Firm Decline
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 15192
PY  - 2009
Y2  - July 2009
UR  - http://www.nber.org/papers/w15192
L1  - http://www.nber.org/papers/w15192.pdf
N1  - Author contact info:
Gian Luca Clementi
Department of Economics
Stern School of Business
New York University
44 West Fourth Street
New York, NY 10012
Tel: 212/998-0268
Fax: 212/995-4218
E-Mail: clem@nyu.edu

Thomas F. Cooley
Department of Economics
Stern School of Business
44 West 4th Street, Room 7-88
New York, NY  10012-1126
Tel: 212/998-0870
Fax: 212/995-4218
E-Mail: tcooley@stern.nyu.edu

Sonia Di Giannatale
Centro de Investigacion y Docencia Economicas
Mexico D.F.
Mexico
E-Mail: sonia.digiannatale@cide.edu
AB  - We study the problem of an investor who buys an equity stake in an entrepreneurial venture, under the assumption that the former cannot monitor the latter’s operations. The dynamics implied by the optimal incentive scheme is rich and quite different from that induced by other models of repeated moral hazard. In particular, our framework generates a rationale for firm decline. As young firms accumulate capital, the claims of both investor (outside equity) and entrepreneur (inside equity) increase. At some juncture, however, even as the latter keeps on growing, invested capital and firm value start declining and so does the value of outside equity. The reason is that incentive provision is costlier the wealthier the entrepreneur (the greater is inside equity). In turn, this leads to a decline in the constrained–efficient level of effort and therefore to a drop in the return to investment.
ER  -