Debt and equity as optimal contracts

This paper shows the simultaneous optimally of debt and equity contracts in a principal-agent model. The agent (an entrepreneur) has an investment project but does not have the necessary funds to finance it. There is moral hazard in the model, generated by the dependence of the project's expected return on the (unobservable) agent's effort. Key to the optimality of these financial instruments is the nonassignable rent produced by the project and captured by the entrepreneur when the investment is successful.