7. Nonverifiable Income

Question 1

What do we aim to look at with nonverifiable income and what do we find?

Answer 1

We ask if it’s possible to have any loan agreements when the lenders are completely unable to verify project returns. We find that it might be possible to find solutions to the incentive problem as long as we extend the time horizon of projects. We also find that the problem has interesting applications for intermediate finance and sovereign debt

Question 2

Summarise the model

Answer 2

Date 1 investment I yields R1 with prob p and o with prob 1-p
Date 2 the initial investment if not terminated yields expected outcome R2. If the project is liquidated at the end of date 1, lenders receive liquidation value L and the entrepreneur receives nothing

Question 3

Remark 1

Answer 3

Given that 0 belongs to the support of the distribution of R2 the entrepreneur repays nothing at date 2

Question 4

What do we assume about liquidation level?

Answer 4

Insufficient liquidation L<R2. The continuation value of the project is higher than its liquidation value