We show that short-term debt in a firm’s optimal capital structure reduces investment under asymmetric information. Investors’ interpretation of underinvestment as a positive signal about the quality of the assets in place allows the equity holders to profit from short-term debt repricing at...

We develop a model that explains two stylized facts - the coarseness of credit ratings relative to the underlying default probabilities, and the countercyclical nature of ratings imprecision. The imprecise nature of coarse ratings arises from the revenue-maximizing behavior of rating agencies,...

This paper derives conditions under which the introduction of a third-party agent solves the renegotiation-proofness problem of Moore and Repullo (1988)-type mechanisms, without introducing the potential for other agents to collude with the third-party. The key novelties of our mechanism are:...

We show that when borrowers are privately informed about their creditworthiness and lenders have a soft budget constraint, efficient investment requires a limit on the fraction of a firm’s cash flows that can be pledged to outsiders. That is, pledgeability should neither be too low nor too...

We analyze competitive credit markets with asymmetric information in which borrowers seek financing for either positive or negative net present value projects. The striking result is that there always exists an equilibrium where investment is efficient, while competitive lenders make strictly...

Classical security design papers equate competitive capital markets to securities being fairly-priced in expectation. We revisit the adverse selection setting of Nachman and Noe (1994), modeling capital-market competition as free entry of investors, and allowing firms to propose a price for the...

We show that in the limited-commitment framework of Donaldson, Gromb and Piacentino (2019), firm value always increases in the fraction of cash flows that can be pledged as collateral. That is, pledgeability increases investment efficiency and relaxes a firm's financing constraint. We derive...