Renegotiation and the impossibility of optimal investment

In a model with asymmetric information and external equity financingit is impossible to achieve socially optimal investment becauseof renegotiation possibilities. The contractual solution suggestedby Dybvig and Zender (1991) is not dynamically consistent -the manager's contract would be renegotiated, resulting in inefficientinvestment. Moreover, no other compensation contract that wouldinduce the manager to invest efficiently survives renegotiation.Contracts that pay the manager based on the stock price, whileproducing suboptimal investment as in Myers and Majluf (1984),are robust to renegotiation.