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A Theory of Predation Based on Agency Problems in Financial Contracting

Patrick Bolton and David S. Scharfstein
The American Economic Review
Vol. 80, No. 1 (Mar., 1990), pp. 93-106
Stable URL: http://www.jstor.org/stable/2006736
Page Count: 14
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A Theory of Predation Based on Agency Problems in Financial Contracting
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Abstract

By committing to terminate funding if a firm's performance is poor, investors can mitigate managerial incentive problems. These optimal financial constraints, however, encourage rivals to ensure that a firm's performance is poor; this raises the chance that the financial constraints become binding and induce exit. We analyze the optimal financial contract in light of this predatory threat. The optimal contract balances the benefits of deterring predation by relaxing financial constraints against the cost of exacerbating incentive problems.

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