Risk-shiting Incentive Problem and Debt Concession

Risk-shifting incentive problem in financial contracting, which typically arises in the context of a lenderborrower relationship, stands for the borrower’s incentive to influence the risk of his project. Thus, the borrower can increase the value of his payoff at the expense of the lender. However, the lender also may have a risk incentive under some circumstances so that he may render it difficult to do efficient debt renegotiation. In this paper, we focus on not only borrower’s risk incentive but lender’s risk incentive problems and the relation between the both sides is discussed since the lender’s risk incentive may cause to accelerate the possibility of borrower’s risk incentive. Thus, when either side even selects a risky project instead of a safe one the inefficiencies of resource distribution are developed. We analyze the incentive problem, in which option pricing theory is used and some barriers must be attached to the option pricing formula in order for the formula to be justified. Keywords— Barrier option, Debt concession, Lender and borrower, Option pricing, Risk-shifting incentive