Leverage and risk taking

Sntiago Moreno-Bromberg, Guillaume Roger

Research output: Contribution to conferencePaperpeer-review

Abstract

We study a dynamic contracting problem in which size is relevant. The agent may take on excessive risk to enhance short-term gains, which exposes the principal to large, infrequent losses. To preserve incentive compatibility, the optimal contract uses size as an instrument; there is downsizing on the equilibrium path. The contract may be implemented using the full array of financial securities or as a regulation contract with a leverage ratio. We show that holding equity is essential to curb risk taking. Firms that are less prone to risk taking can afford a higher leverage.
Original languageEnglish
Number of pages54
Publication statusPublished - 2016
Externally publishedYes
EventFinancial Institutions, Regulation and Corporate Governance Conference 2016: Bitcoins, Hedge Funds and Tennis Balls - The University of Melbourne, Melbourne, Australia
Duration: 22 Jan 201623 Jan 2016
Conference number: 1st
https://mbs.edu/fircg/fircg-2016

Conference

ConferenceFinancial Institutions, Regulation and Corporate Governance Conference 2016
Abbreviated titleFIRCG 2016
CountryAustralia
CityMelbourne
Period22/01/1623/01/16
Internet address

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