Document Type

Working Paper

Publication Date

5-22-2010

Working Paper Number

WP #10006, May 2010

Abstract

A social planner wishes to launch a project but the contenders capable of running the project are cash-constrained and may default. To signal their capabilities, the contenders may finance their bids through debt or equity, depending on the mechanism chosen by the social planner. When moral hazard is absent, it is established as theorems that the ex post efficient social choice function cannot be achieved by any mechanism using only debt financing and can be achieved by a mechanism using equity financing. When moral hazard is present, however, it is illustrated heuristically that equity share discourages effort and exacerbates default more than risky debt does.

JEL Classification

D44, D92

File Format

application/pdf

Length

22 pages

Included in

Economics Commons

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