RISK AVOIDANCE UNDER LIMITED-LIABILITY

When the expected flow returns from an investment is positive, bancrup tcy carries a cost in terms of the future profit opportunities forgone . This paper demonstrates that, under limited liability, the one-shot gain from taking risky projects is offset by the long-term loss result ing from a higher probability of bankruptcy. In a multi-period model, the incentive problems associated with limited liability is less sever e than what static models would suggest. (C) 1995 Academic Press, Inc.