Financial Contracting And The Specialization Of Assets

The authors analyze the nature of financial contracting when an entrepreneur can choose the specificity of investments and financial contracts are incomplete. Investing in project specific assets increases productivity but decreases liquidation value. This creates a strategic incentive to specialize assets to decrease the bargaining power of the lender, which may make debt financing infeasible. By contrast, equity financing provided by a financier who contributes to the project, such as a VC, may be feasible because his contribution becomes more valuable as assets become more specialized.