Working Paper: NBER ID: w28367
Authors: Aifan Ling; Jianjun Miao; Neng Wang
Abstract: We study how investors' preferences for robustness influence corporate investment, financing, and compensation decisions and valuation in a financial contracting model with agency. We characterize the robust contract and show that early liquidation can be optimal when investors are sufficiently ambiguity averse. We implement the robust contract by debt, equity, cash, and a financial derivative asset. The derivative is used to hedge against the investors' concern that the entrepreneur may be overly optimistic. Our calibrated model generates sizable equity premium and credit spread, and implies that ambiguity aversion lowers Tobin's q; the average investment, and investment volatility. The entrepreneur values the project at an internal rate of return of 3.5% per annum higher than investors do.
Keywords: financial contracting; investment; ambiguity aversion; dynamic contracting; corporate finance
JEL Codes: D81; E22; G12; G32; J33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| ambiguity aversion (D81) | early liquidation (G33) |
| ambiguity aversion (D81) | trust in entrepreneurs (L26) |
| trust in entrepreneurs (L26) | early liquidation (G33) |
| ambiguity aversion (D81) | belief wedge (I30) |
| belief wedge (I30) | investment levels (F21) |
| belief wedge (I30) | performance sensitivity (D29) |
| ambiguity aversion (D81) | Tobin's q (G19) |
| ambiguity aversion (D81) | average investment (G11) |
| ambiguity aversion (D81) | investment volatility (G17) |
| ambiguity aversion (D81) | corporate investment dynamics (G31) |