Risk, Limited Liability and Firm Scope

Risk, limited liability and firm scope

This paper provides a new explanation for the relationship between firm scope, agent's effort and corporate risk. I set up a moral hazard in teams model with multiple agents and departments under the assumption that both the principal and the agents are protected by limited liability. Each agent exerts effort to reduce the probability of loss of his department. The two-sided limited liability a...

Limited Liability and the Risk- Incentive Relationship

Several empirical findings have challenged the traditional view on the trade-off between risk and incentives. By combining risk aversion and limited liability in a standard principal-agent model the empirical puzzle on the positive relationship between risk and incentives can be explained. Increasing risk leads to a less informative performance signal. Under limited liability, the principal may...

Optimal Risk Sharing With Limited Liability∗

We solve the general problem of optimal risk sharing among a finite number of agents with limited liability. We show that the optimal allocation is characterized by endogenously determined ranks assigned to the participating agents and a hierarchical structure of risk sharing, where all agents take on risks only above the agent-specific thresholds determined by their ranks. When all agents have...

Limited Liability and the Trade-off between Risk and Incentives

Risk Taking, Limited Liability and the Competition of Bank Regulators

Limited liability and asymmetric information between an investment bank and its lenders provide an incentive for a bank to undercapitalise and finance overly risky business projects. To counter this market failure, national governments have imposed solvency constraints on banks. However, these constraints may not survive in systems competition, as systems competition is likely to suffer from th...