Essays on Optimal Contracting

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The first chapter of this dissertation studies a continuous-time agency model where the agent controls the drift of the geometric Brownian motion firm size. The changing firm size generates partial incentives, analogous to awarding the agent equity shares according to her continuation payoff. When the agent is as patient as investors, performance-based stock grants implement the optimal contract. My model generates a leverage effect on the equity returns, and implies that the agency problem is more severe for smaller firms. That the empirical evidence shows that grants compensation are largely based on CEO's historical performance---rather than current performance---lends support to my model model. The second chapter studies the optimal contracting problem in the commonly used cash-flow setup, and offers a general framework to quantitatively assess the impact of agency problem. When cash-flow follows a square-root mean-reverting process, I derive the optimal contract in closed form, and provide a calibration exercise for the agency cost based on the empirical estimates of pay-performance sensitivity and cashflow mean-reverting intensity. In the geometric Brownian cash-flow setup, I embed the agency problem into Leland (1994), and find that small firms will take less leverage in choosing their optimal capital structure. The third chapter generalizes the Leland and Pyle (1977) model to the case of multiple correlated assets. There, I study the signaling and hedging behavior of an intermediary with multi-dimensional private information who trades multiple assets in financial markets. Based on information asymmetry, the model demonstrates the intrinsic interdependence of risk management and asset selling for intermediaries, and obtains several testable empirical implications. For instance, an intermediary with a more diversified underlying portfolio will face greater liquidity (a smaller price impact) when communicating true asset qualities to the market. Several applications are discussed, including bank loan sales and selling mechanisms.

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  • 08/31/2018
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