Despite operating under substantial regulatory constraints, we find that commercial banks manage their investments largely consistent with the predictions of portfolio choice models with capital market imperfections. Based on 1990-2002 data for small (assets less than $1 billion) U.S. commercial...

We analyze how optimal contracting between an entrepreneur and a financial institution depends on the cash flow characteristics of the entrepreneur's firm. Because the entrepreneur prefers continuing the firm over liquidating it, and aggressive continuation strategies over conservative...

We analyze how entrepreneurial firms choose between two funding institutions: banks, who monitor less intensively and face liquidity demands from their own investors, and venture capitalists, who can monitor more intensively but face a higher cost of capital due to the liquidity constraints that...

Theory suggests that banks' private information about borrowers lets them hold up borrowers for higher interest rates. Since hold-up power increases with borrower risk, banks with exploitable information should be able to raise their rates in recessions by more than is justified by borrower risk...

Firms sometimes commit fraud by altering publicly reported information to be more favorable, and investors can monitor firms to obtain more accurate information. We study equilibrium fraud and monitoring decisions. Fraud is most likely to occur in relatively good times, and the link between...

A financial institution that finances and monitors firms learns private information about these firms. When the institution seeks funds to meet its own liquidity needs, it faces adverse selection (quot;liquidityquot;) costs that increase with the risk of its claims on these firms. Thus, the...

We show that exposure from past business transactions ? risk overhang ? can reduce activity in related business lines, sometimes to the point where no new trade occurs. We focus primarily on the role of overhang in nonlife insurance market disruptions. Our model predicts that the relative...

Many models predict that the diversification and efficiency of financial intermediaries (quot;banksquot;) increases with their size, so that a relatively unrestricted banking sector will settle into an equilibrium with several large, well-diversified, and competitive banks. However, this...

Many financial claims specify fixed maximum payments, varying seniority, and absolute priority for more senior investors. These features are motivated in a model where a firm's manager contracts with several investors and firm output can only be verified privately at a cost. Debt-like contracts...

An institution that gathers information about a firm whose shares it holds can use this information for two purposes: speculation, and costly intervention aimed at improving the firm's performance. Its incentive to intervene has two components: the direct impact on its existing position, and the...