Bailouts, Time Inconsistency, and Optimal Regulation

Público
Creator Series Issue number
  • 481
Date Created
  • 2013-04-26
Abstract
  • We develop a model in which, in order to provide managerial incentives, it is optimal to have costly bankruptcy. If benevolent governments can commit to their policies, it is optimal not to interfere with private contracts. Such policies are time inconsistent in the sense that, without commitment, governments have incentives to bail out firms by buying up the debt of distressed firms and renegotiating their contracts with managers. From an ex ante perspective, however, such bailouts are costly because they worsen incentives and thereby reduce welfare. We show that regulation in the form of limits on the debt-to-value ratio of firms mitigates the time-inconsistency problem by eliminating the incentives of governments to undertake bailouts. In terms of the cyclical properties of regulation, we show that regulation should be tightest in aggregate states in which resources lost to bankruptcy in the equilibrium without a government are largest.

Subject (JEL) Palabra Clave Related information Corporate Author
  • Federal Reserve Bank of Minneapolis. Research Department
Publisher
  • Federal Reserve Bank of Minneapolis
Resource type DOI
License

Relaciones

En Collection:

Contenido Descargable

Descargar PDF

Zipped Files

Download a zip file that contains all the files in this work.

Elementos