Insolvency Timing as an Agency Problem

Abstract

Agency theory is prevalently used in the literature to analyze the institutional features of contractual relationships between economic agents. Frequently, it is also subsumed under the broader terms of contract theory or theory of incentives. It forms an integral part of new institutional economics, which also encompass the concepts of property rights and transaction costs. These concepts were developed in reaction to the Neoclassical Equilibrium Theory's failure to explain the existence and structure of institutions, as it assumes homogeneous and complete information as well as no transaction costs, among other factors. In contrast, new institutional economics builds on information asymmetries, incomplete contracts, utility-maximizing behavior, (bounded) individual rationality, and the existence of transaction costs. With these assumptions, it is possible to yield results closer to economic reality by accounting for individual utilitymaximizing behavior and limitations of contractual agreements.