We consider the security design problem of a lender who can assess the borrower s project prior to making an accept or reject decision. The lender s subjective assessment is represented by a private signal. Unless the lender extracts the full surplus from the project, her cutoff signal above...

Future wage payments drive a wedge between total firm output and the output share received by the firm s owners, thus potentially distorting strategic decisions by the firm s owners such as, e.g., whether to continue the firm, sell it, or shut it down. Using an optimal contracting approach, we...

This paper considers the potential cost of subjective judgment and discretion in credit decisions. We show that subjectivity and discretion in the evaluation of borrowers create an incentive problem on the part of the lender. The lender s incentives to accept or reject a borrower depend only on...

We offer a novel explanation for the use of collateral based on the dual function of banks to provide credit and assess the borrower s credit risk. There is no moral hazard or adverse selection on the part of borrowers the only inefficiency is that banks cannot contractually commit to providing...

This paper compares optimal financial contracts with centralized and decentralizedfirms. Under centralized contracting headquarters raises funds on behalf of multiple projects and then allocates the funds on the firm s internal capital market. Under decentralized contracting each project raises...

This paper considers the potential cost of subjective judgement and discretion in credit decisions. We show that subjectivity and discretion in the evaluation of borrowers create an incentive problem on the part of the lender. The lender s incentives to accept or reject a borrower depend only on...

If ownership and control are separated, leaving the manager with discretion may be of value. This paper discusses the extent to which a firm's ownership structure may serve as a commitment for shareholders not to interfere with the manager's project decisions, thereby reducing the agency cost of...

This paper considers a competitive search market where sellers have private information about a good's quality. It is shown that separation of types may arise naturally if high-quality sellers derive a greater utility from search than low-quality sellers. For instance, sellers of high-quality...

In a seminal paper, Rothschild and Stiglitz (1976) show that competitive markets with incomplete information in which firms offer contracts to screen privately informed agents may have no equilibrium. In this paper, we argue that frictions in the form of delay or congestion provide a natural...

In an internal capital market, individual departments may compete for a share of the firm's budget by engaging in wasteful influence activities. We show that firms with more levels of hierarchy may experience lower influence costs than less hierarchical firms, even though the former provide more...