Early-Warning Signals and Risk-Shifting Incentives

ABSTRACT We study the optimal information system in a debt contracting setting which managers can engage value destroying risk-shifting behavior. The issues early-warning signals that allow lenders to take corrective actions such as liquidating unprofitable projects. When are empire builders, exhibits conservative bias leads excessive and project liquidations relative first best. In contrast, when have strong preference for quiet life, liberal insufficient continuations. broad intuition is (continuations) impose costs on who building (a life), these more severe risks. therefore permits commit not risk shifting facilitates financing. JEL Classifications: G30; G32; M40; M41.