Working Paper: CEPR ID: DP15757
Authors: Piero Gottardi; Vincent Maurin; Cyril Monnet
Abstract: We study the effect of investment growth on firms' incentives under moral hazard. Adding value-increasing, but risky projects to a firm's portfolio can weaken incentives for safer ones, even when returns are independent. While the firm diversifies its sources of income, this risk contamination channel can increase its fragility. Such fragility is exacerbated in the presence of news about the value of investments. Firms can mitigate these effects by selecting safer new investments at the expense of value creation. Our model thus predicts that large firms or merged firms may be riskier or less productive than smaller firms.
Keywords: collateral; credit chains; secured lending; intermediation; fragility
JEL Codes: G23; G30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| riskiness of collateral (G33) | intermediary's incentives (L14) |
| intermediary's incentives (L14) | fragility in credit chain (F65) |
| arrival of news about collateral value (G14) | fragility in credit chain (F65) |
| riskiness of collateral (G33) | probability of default (G33) |
| intermediary's incentives (L14) | probability of default (G33) |
| arrival of news about collateral value (G14) | intermediary's behavior (D16) |
| riskiness of collateral (G33) | increased fragility (F12) |