This paper considers a problem of security design in the presence of monitoring done by a large investor to discipline the management of a firm. Since the large investor enjoys only part of the benefits generated by her monitoring activities but incurs all the associated costs, the design and amount of security need to be structured so as to motivate her to maintain an efficient level of monitoring, if no other mechanism exists to make her commit to specific levels of monitoring in advance. By assuming that the large investor takes account of the effect of the issued amount of security on the revenues received, we show that the optimal security is a debt-like security such as standard debt with a positive probability of default, or debt with call options. We also verify that the financial market equilibrium is constrained Pareto optimal.

This paper considers whether the first-best level of firm-specific human capital investment is attained by the use of stock option plans for workers and stock offers in acquisitions even though workers are threatened with the possibility of a divestiture and acquisition. We show that the first-best level of investment is achieved by a stock option plan with a positive exercise price for workers conditional on the event of a divestiture. We also suggest that, under certain conditions, a stock offer in acquisition can resolve a collusion problem between the target firm (TF) and its workers.

Under the incomplete contract framework, we consider an optimal regulatory policy for motivating bank equity owners and bank managers to restructure the bad loans of their banks in the presence of managerial compensation contracts with stock options. The regulatory policy studied in this paper is mainly concerned with the design of repayment schedules in the scheme of injection of cash funds into insolvent banks by the regulator. We show that the regulator cannot necessarily attain the social optimal allocation by injecting cash funds into insolvent banks through the purchase of subordinated bonds with the risk-free interest rate. However, even in that case, we also suggest that, if the regulator injects cash funds into active restructuring banks through the purchase of subordinated bonds or preferred stocks with less stringent repayment conditions and nationalizes passive restructuring banks, the regulator can attain the social optimal allocation by performing such a non-linear injection scheme under certain conditions.

The purpose of this paper is to specify a formal model that rationalizes the intercorporate shareholdings observed in the Japanese equity market as a mechanism for mutual commitment and risk sharing that creates greater possibilities to resolve managerial myopic problems caused by the threat of external takeovers. We show that, under certain conditions, all agents including the existing shareholders of the firm are strictly better off when participating in an implicit contract associated with intercorporate shareholdings. The results also suggest that intercorporate ownership raises the stock prices of the member firms.

We consider the role of the nonrecourse financing of securitization by a financial institution (FI). Our model suggests that even though the FI has the opportunity to provide liquidity support afterward, it is optimal for the FI to use the nonrecourse financing of securitization initially, because the nonrecourse security makes liquidation of the original asset more attractive for an FI that knows that the original asset is bad. However, our model also predicts that the nonrecourse financing of securitization, together with short-term maturity financing, forces the financial system to perform inefficiently in handling troubled loans and causes problems with inefficient liquidity support and overinvestment under certain conditions, despite the nonrecourse property of securitization. The theoretical results provide empirical implications for recent problems with securitized and structured finance in the United States and Europe.

This paper considers what kind of managerial compensation contract is optimal for mitigating the moral hazard decision regarding investment timing. We examine the situation where the personal objectives of managers do not align with those of shareholders and where there is the possibility of project liquidation but where managerial compensation is endogenously determined. Using a real options approach, we show that restricted stock is optimal relative to stock options under various circumstances. However, we also suggest that stock options are more likely to be used instead of, or in addition to, restricted stock in firms with new debt financing and more impatient managers, diversified firms involving more complicated business activities, and firms with weaker corporate governance. In addition, we find that project start-up is more likely to be deterred by the greater likelihood of project liquidation and larger managerial effort cost, whereas the amount of stock-based managerial compensation is independent of the probability of liquidation but is increasing in managerial effort cost.

The implicit contract theory explored by Azariadis [2] suggests that wage rigidity and underemployment are explained by the microeconomic optimizing behavior of each agent in the labor market. In this theory, the former phenomenon is interpreted as risk-sharing arrangements between firms and workers, whereas the latter may occur when workers have the opportunity to use leisure or unemployment insurance benefits.