Dynamic Moral Hazard, Risk-Shifting, and Optimal Capital Structure [pdf] 

I develop an analytically tractable model that integrates the risk-shifting problem between bondholders and shareholders with the moral hazard problem between shareholders and the manager. The presence of managerial moral hazard exacerbates the risk-shifting problem. An optimal contract binds shareholders and the manager. The flexibility of this contract allows shareholders to relax the incentive constraint of the manager when a good profitability shock is drawn. Hence, the optimal contract amplifies the upside thereby increasing shareholder appetite for risk-shifting. Moreover, some empirical studies find a positive relation between risk-shifting and leverage, while others studies find a negative relation. The model predicts a non-monotonic relation between risk-shifting and leverage and has the potential to reconcile this empirical evidence. Implications for capital structure, business cycles and executive compensation are also considered.
Robust Contracts in Continuous Time (with Jianjun Miao) [pdf] , under revision for resubmission to Econometrica
We study two types of robust contracting problem under hidden action in continuous time. In type I problem, the principal is ambiguous about the project cash flows, while he is ambiguous about the agent's beliefs in type II problem. The principal designs a robust contract that maximizes his utility under the worst-case scenario subject to the agent's incentive and participation constraints. We implement the optimal contract by cash reserves, debt and equity. In addition to receiving ordinary dividends when cash reserves reach a threshold, outside equity holders also receive special dividends or inject cash in the cash reserves to cope with model misspecification. Ambiguity aversion lowers outside securities value and raises the credit yield spread. It generates equity premium for type I problem, but not for type II problem. The equity premium and the credit yield spread are state dependent and high for distressed firms with low cash reserves.

Accounting Frictions: Implications for the Business Cycle (pdf available upon request)
Credit constraints have been shown to be a powerful mechanism by which small shocks to productivity are amplified and propagated through the economy. This paper explores the consequences of incorporating accounting frictions into the traditional models that generate business cycles through credit constraints. Borrowers and lenders don't mark their assets to market on a regular basis, instead they are often reluctant to write down the value of their assets after the market price goes down. The interaction of this accounting friction with the credit constraints has important implications for the amplification and propagation of shocks, as well as for the cyclicality induced in the economy.