Banks are optimally opaque institutions. They produce debt for use as a transaction medium (bank money), which requires that information about the backing assets - loans - not be revealed, so that bank money does not fluctuate in value, reducing the efficiency of trade. This need for opacity...

This paper discusses how economists' views of firms' financial structure decisions have evolved from treating firms' profitability as given; to acknowledging that managerial actions affect profitability; to recognizing that firm value depends on the allocation of decision or control rights. The...

We present a DSGE model where firms optimally choose among alternative instruments of external finance. The model is used to explain the evolving composition of corporate debt during the financial crisis of 2008-09, namely the observed shift from bank finance to bond finance, at a time when the...

This paper analyzes a class of competitive economies with production, incomplete financial markets, and agency frictions. Firms take their production, financing, and contractual decisions so as to maximize their value under rational conjectures. We show that competitive equilibria exist and that...

Intuition suggests that firms with higher cash holdings are safer and should have lower credit spreads. Yet empirically, the correlation between cash and spreads is robustly positive and higher for lower credit ratings. This puzzling finding can be explained by the precautionary motive for...

I build a dynamic capital structure model that demonstrates how business-cycle variations in expected growth rates, economic uncertainty, and risk premia influence firms' financing and default policies. Countercyclical fluctuations in risk prices, default probabilities, and default losses arise...

Firm entry dynamics are an integral part of the propagation of financial shocks to the real economy. A VAR documents that adverse financial shocks in the U.S. postwar period are associated with a fall in new firm creation and a fall in firm equity values. We propose a DSGE model with endogenous...

The cost of capital plays an important role in the allocation of resources among competing uses in a decentralized market system. The purpose of this paper is to organize and present what is known and what is hypothesized about the effects of taxation on the incentive to invest, via the cost of...

This paper develops a model to study how entrepreneurs and venture-capital investors deal with moral hazard, effort provision, asymmetric information and hold-up problems. We explore several financing scenarios, including first-best, monopolistic, syndicated and fully competitive financing. We...

Evidence on the 'funding gap' for R&D is surveyed. The focus is on financial market reasons for underinvestment in R&D that persist even in the absence of externality-induced underinvestment. The conclusions are that 1) small and new innovative firms experience high costs of capital that are...