ANTI-COMPETITIVE FINANCIAL CONTRACTING: THE DESIGN OF FINANCIAL CLAIMS.

R_b^H₂ - R_b^L₂ = Ψ⁰ (e2)

Rb^L2 ≥ 0, Rb^H2 ≥ 0

Now, will the investor want to strike a deal with Firm 2 ? In other words,
will an investor’s ”Coase problem” arise, whereby the investor (ex-post) op-
timally floods the industry with financial funds? The answer is “yes” if the
following condition holds:

e^M(R^H - Ψ⁰(e^M)) + (1 - e^M)R^L <

(e^M-∆)(R^H-Ψ⁰(e^M))+(1-e^M+∆)R^L+V2

The left-hand side of th_nis inequality is the valu_oe of the investor’s claim in
Firm 1 when the contract R_b^L =0,R_b^H = Ψ⁰(e^M) is in force and Firm 2 is
not funded. The right-hand side is the value of the investor’s claim in F1 when
the same contract holds and Firm 2 is funded, plus the return from funding
Firm 2.

This can be rearranged as condition (1):

∆(R^H - R^L - Ψ⁰(e^M)) < V2                    (1)

When deciding whether to fund Firm 2, the investor trades off the addi-
tional payoff V2 with the reduced value of his claim in Firm 1 induced by
market competition. As competition reduces the probability of success of both
firms, the investor’s claim is affected by Firm 2’s entry only if it is risky, that
is, if R^H - Ψ⁰(e^M) >R^L. Also, the riskier the investor’s claim, the less will he
be tempted to fund Firm 2.

The above reasoning underlines the first important result of our paper: an
investor holding sufficiently safe debt in a firm will always find it optimal to
fund the firm’s rivals.

Knowing that the investor will be tempted t_no supply a second firm e_ox-post,
the first entrepreneur will accept the contract R_b^L =0, R_b^H = Ψ⁰(e^M) if and
only if: W ≤ W0 =(e^M - ∆)Ψ⁰ (e^M) - Ψ(e^M), that is, whenever his reservation
wage is very low. When W is larger than W0 the entrepreneur will not accept
this contract and the investor will bear ex-ante all the cost of his future lack
of commitment, obtaining just the duopoly profits (net of agency rents) from
the industry. It is in this case that the investor will look for a contractual
solution to eliminate the temptation of opportunism. As we are interested in
analyzing this contractual response to the Coase problem, in what follows we
will assume W>W0 .

4 Excluding Firm 2

We have seen that an investor’s Coase problem arises whenever his claim sat-
isfies condition (1). If he wants to preserve the innovating firm’s monopolistic

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