Concepedia

A Theory of Predation Based on Agency Problems in Financial Contracting

American Economic Review · 1990 · 659 citations · 9 references

TL;DR

Investors can mitigate managerial incentive problems by committing to terminate funding for poor performance, but such constraints can incentivize rivals to sabotage performance, increasing the likelihood of binding constraints and firm exit. The study examines how optimal financial contracts should be designed to counter predatory threats. The contract design trades off relaxing constraints to deter predation with the risk of worsening incentive problems. © 1990 American Economic Association.

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. The authors 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. Copyright 1990 by American Economic Association.