ASYMMETRIC INFORMATION AND CONTRACTUAL ARRANGEMENTS: APPLICATIONS TO ASSET MANAGEMENT AND PROJECT FINANCING

This dissertation is a study of contracts. The objectives of the research are twofold. The first is to characterize the sharing rules envisaged in the contracts and the second is to interpret the equilibrium results to determine their implication for the observed behavior of firms. The research is motivated by the hypothesis that the observed behavior of firms is a manifestation of the conflicts of interest among the various groups connected with the firm.;The second part of the dissertation examines a contractual arrangement between sponsors of projects (firms) and its creditors in an economy characterized by asymmetric information (regarding project risk) between sponsors and creditors. It is shown that the creditors use the amount of debt they provide to a project as a control instrument to induce the sponsors to reveal the riskiness of their projects. A fully revealing reactive equilibrium is derived in which the riskier projects are awarded higher debt. It is shown that firms have incentives to set up certain projects separate from their other facilities to facilitate acquisition of more debt. This separation of assets is regarded as an economic justification for the observed practice of "project financing".;Finally, several contractual arrangements (used in joint venture project financing) to repay project debts are analyzed to determine the conditions under which alternative arrangements would Pareto dominate.;In the first part of the dissertation the investment decision process of a managerially operated firm is analyzed. It is assumed that managerial actions are not observable to the owners and that there is asymmetric information between the owners and managers regarding the return distribution of the firms project. A general linear managerial incentive contract is studied, which not only motivates the manager but also induces him to truthfully reveal his private information to the owners. The revelation process is used to justify a centralized capital budgeting system for firms. The analysis shows that riskier projects with positive net present values would be rejected by the owners and that managers gain from their private information at the expense of the owners. The model also shows that managers would have incentives to seek conglomerate mergers.