Dynamic Financing Contract:Theory And Application

The MM theorem proposed by Modigliani and Miller(1958) tells that in a perfect world, the ways of financing does not matter. But in the real world, private information exists everywhere. Thus different ways of financing will bring firm different benefits. Scholars usually analyze the optimal financing contract in principal-agent model. They find that dynamic contract has advantage in mitigating the information problem. This dissertation uses dynamic contract to solve firm’s financing problem under different information structures.Firstly, we assume the length of contract is endogenous in the model. We find that in the optimal contract, the relationship of two parties can be suspended over any arbitrary number of periods and then resumes. This could help us to understand why sovereign debt has default cycles.Next, we analyze the effect of labor mobility on firm’s financing constraint. We use the return of capital to measure financing constraint. When labor can not freely move, the returns of capital in different firms will converge. When labor can freely move, labor will increase with the size of firm, which will make firm’s capital return unchage. This model tells us when there exists large amount of surplus labor force in China’s rural areas, the capital return of financing constrained firms will stay at high level. It will decrease when surplus labor force disappear.Last we consider an informal financing channel:trade credit. We find that trade credit exists in most of firms, even in those rich enough firms. The ratio of trade credit to input firstly decrease with firm’s net worth and stay constantly afterwards. To understand these phenomena, we build a model with monopolized uspstream market. In the model, bank, upstream firm and downstream firm interact with each other. When combine the financing and transactional purpose of trade credit, we find out that the cost of trade credit is lower than bank loan. So it is provided to not only those financial constrained firms, but also those wealthy enough firms. We also find out that with trade credit, downstream firms would consume less to leave more to the next-period, and thus grow quickly.