In a financial contracting environment asymmetric information may determine whether two projects are incorporated jointly as a single firm or separately as legally distinct entities. The choice between incorporation modes depends on the trade-off between two types of inefficiency: adverse selection and under-investment in growth options. Joint incorporation can lead to a premature exercise pooling equilibrium while separate incorporation may exacerbate under-investment tendencies. Also, when joint incorporation is optimal a contractual covenant to this effect may be required to overcome a time-inconsistency problem. the model is consistent with the stylised facts that riskier ventures are more likely to be project financed (separate incorporation) and that leverage ratios are higher than for conventional financing (joint incorporation).
Download is not available
