An Incomplete Contracts Approach to Financial Contracting.

The authors analyze incomplete long-term financial contracts between an entrepreneur with no initial wealth and a wealthy investor. Both agents have potentially conflicting objectives, the entrepreneur cares about both pecuniary and nonpecuniary returns from the project while the investor is only concerned about monetary returns. The authors address (1) whether the initial contract can be structured in such a way as to bring about a coincidence of objectives between both agents and (2) when the initial contract cannot achieve this coincidence how should control rights be allocated to achieve efficiency? One of the main results concerns the optimality properties of standard debt financing. Copyright 1992 by The Review of Economic Studies Limited.