Capital Rationing Under Perfect Information

In this paper, we discuss a scenario in capital structure where two divisional managers compete for capital from a firm for their projects in a perfect information setting. Each project’s profit is an inverted u-shape function with respect to capital. We consider verifiable profits and study take-it-or-leave-it contracts (complete) where the managers ask for capital from the firm privately or sequentially in public and offer a part of the profit to the firm. Under capital constraint, we demonstrate that in private meeting, there is no sub game perfect Nash equilibrium (SPNE); but in sequential public meeting, SPNE exists and for the firm it is better to operate under capital constraint to increase the competition among managers. We derive the equilibrium financial contracts that the managers are awarded and the optimal capital rationing for the firm to gain maximum profit