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Lecture12 - 13 - agency moral hazard adverse selection


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Unformatted text preview: d the market prices their car at V H. If they do not offer a guarantee, and the market prices their car at V L, the no­ mimicking condition is: VH > VL [sellers of good will not mimic sellers of bad] 28 Signaling Equilibrium The “signaling equilibrium” must satisfy: 1) The equilibrium market valuation of cars: V = VH if a guarantee is offered V = VL if a guarantee is not offered 2) The two no­mimicking conditions: VL > VH – Cb [sellers of bad will not mimic sellers of good] VH > VL [sellers of good will not mimic sellers of bad] Both types of cars are sold, so this is a big improvement. However, sellers of good cars may incur unnecessary costs to provide a guarantee (e.g., the cost of writing the contract with a notary). This is the cost of signaling 29 Signaling with Retained Ownership in IPOs An entrepreneur seeks outside equity financing to undertake a risky project with uncertain payoff The entrepreneur needs to choose the α% of the firm’s equity that he will retain The entrepreneur is risk­averse, and is...
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