ps4_without_solution

ps4_without_solution - Econ 138 Problem Set 4 Professor...

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Econ 138 Problem Set 4 Professor Ulrike Malmendier March 20, 2008 1 More on Asymmetric Information We consider a variation of our standard asymmetric-information model. As before we have two types of f rms, a fraction μ of ‘H-types’ and a fraction 1 μ of ‘L-types.’ We now assume that f rms have illiquid assets that are worth either A H (for the H-types) or A L (for the L-types). In addition to having di f erent assets, the two types also have di f erent investment projects. The H-types have a project that returns R H with probability p (and returns 0 otherwise). The L-types have a project that returns R L with probability p (and 0 otherwise). Both projects cost I . 1.1 Part 1 (3 points) Suppose the f rms would like to f nance investment by issuing equity. We now model issuing equity more realistically, namely as pledging a percentage θ of the company to investors. (In class, we typically assumed a f xed contingent payment R R m in case of success and 0 in case of failure. As we discussed, this can be interpreted as an equity issuance. In this exercise, we model the equity issuance more directly to illustrate the equivalence.) Let’s f rstassumethat ,forag iven f nancing contract that pledges a fraction θ of the f rm to investors, both types of f rms would seek f nancing. How large does θ need to be to convince investors to
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ps4_without_solution - Econ 138 Problem Set 4 Professor...

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