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ECO4170A Game Theory with Applications in Corporate Finance

Assignment 4

2022

1. In the model of Myers and Majluf, the condition v < s (H - L) ensures that there exists a separating equilibrium under which only firms of type L carry out the investment project. What is the condition that ensures the existence of a pooling equilibrium under which firms of type H as well as firms of types L both carry out the investment project?

2. In the game between the manager and the stockholders of Ross (1977), the future value of the firm is random and uniformly distributed on the interval [0, t], where t is the upper bound of V1 . The manager knows the value of t, but the stockholders do not, and this is the asymmetry of information. In observing the debt level F chosen by the manager, the stockholders think that the value of t is given by a[F]. In the lecture on the model of Ross, it was shown that a[F] has the following form:

a[F] =     4  LF + c2 .

Compute the debt level F that maximizes the manager’s expected payoff.