Liability Sharing as a Mechanism to Improve Firms' Investment and Liquidation Decisions

This paper investigates the impact of liability sharing on firms' investment and liquidation decisions. We look at a model involving private effort, unverifiable information, and unenforceable liquidation decisions. In this model, there exist simultaneously two typical types of agency problems, i.e., underinvestment (lower effort) and risk seeking (delaying efficient liquidation). We show how firms can mitigate these problems by forming a business group and sharing each other's liabilities. Under certain conditions, such an alliance is an effective commitment by the member firms to provide a higher level of equity investments (higher effort) and to liquidate inefficient assets (lower risk).J. Comp. Econom., December 2000, 28(4), pp. 739–761. University of Amsterdam, 1018 WD Amsterdam, The Netherlands; International Institute for Applied Systems Analysis, A-2361 Laxenburg, Austria, and United Nations University, WIDER, Katajanokanlaituri 6 B, 00160 Henlsinki, Finland.