This article offers an explanation for the substantial variation of credit standards and price competition among banks over the business cycle. As the economic outlook improves, the average default probabilities of borrowers decline. This affects the profitability of screening and causes bank screening intensity to display an inverse U-shape as a function of economic prospects. Low screening activity in expansions creates intense price competition among lenders and loans are extended to lower-quality borrowers. As the economic outlook worsens, price competition diminishes, and credit standards tighten significantly. Deposit insurance may contribute to the countercyclical variation of credit standards.

This article offers an explanation for the substantial variation of credit standards and price competition among banks over the business cycle. As the economic outlook improves, the average default probabilities of borrowers decline. This affects the profitability of screening and causes bank screening intensity to display an inverse U-shape as a function of economic prospects. Low screening activity in expansions creates intense price competition among lenders and loans are extended to lower-quality borrowers. As the economic outlook worsens, price competition diminishes, and credit standards tighten significantly. Deposit insurance may contribute to the countercyclical variation of credit standards. Copyright 2004, Oxford University Press.

This paper studies the effects of hedge disclosure requirements on corporate risk management and product market competition. The analysis is based on a model of market entry and shows that to prevent entry incumbent firms engage in risk management when these activities remain unobserved by outsiders. In the resulting equilibrium, financial markets are well informed and entry is efficient. However, potential attempts for more transparency by additional disclosure requirements introduce a commitment device that provides incumbents with incentives to distort risk management activities thereby influencing entrant beliefs. In equilibrium, firms engage in significant risk-taking. This behavior limits entry and adversely affects the nature of competition in industries.

Abstract This article develops a theory of resource allocation in internal capital markets that is consistent with the empirical finding that multidivision firms bias their investment levels in favor of divisions with weaker investment prospects. Headquarters has private information about the capital productivities of its divisions; therefore, capital allocations in the present serve as a signal to divisional managers about future allocations. To facilitate effort provision, headquarters biases capital allocation so as to not disclose productivity differences across divisions or to credibly signal their absence. The capital allocation bias is time-varying and the relationship between the bias and the difference in average division productivities is inversely U-shaped.

Abstract Firms can grow through internal investment or through acquisition. While internal growth takes time, an acquisition provides cash flows immediately. The opportunity to grow internally affects the price of an acquisition as it is a fall-back option for the acquirer should negotiations break down. Assuming investors do not have full information about the time a firm requires to grow internally, acquirers earn positive returns before the announcement of an acquisition, and there are negative stock price reactions to acquisition announcements. This research provides predictions about how pre-announcement price run-up and negative announcement returns relate to integration costs and synergies from acquisition.

We analyze a firm's optimal choice over the number of creditors and the extent of information disclosed to them. By dealing with many creditors and disclosing essential confidential information, a firm can keep its cost of credit low. This, however, is associated with a relatively high probability that valuable information leaks to competitors, leading to lower expected net returns from product market operations. The importance of these two countervailing effects varies with size, time, industry, and the form of the financial sector, which yields a number of empirically testable hypotheses.

This paper analyzes the optimal capital budgeting mechanism when divisional managers are privately informed about the arrival of future investment projects. Consistent with field study evidence, an optimal allocation mechanism can include a stipulation that a capital request for discretionary investment will be declined with positive probability in the period after a significant investment was made even though this is ex post suboptimal. The model derives a number of empirical predictions regarding capital budgeting and the investment of financially constrained firms.

ABSTRACT This paper develops a theory of strategic trading in markets with large arbitrageurs. If arbitrageurs are not well capitalized, capital constraints make their trades predictable. Other market participants can exploit this by trading against them. Competitors may find it optimal to lend to arbitrageurs that are financially fragile; additional capital makes the arbitrageurs more viable, and lenders can reap profits from trading against them for a longer time. The strategic behavior of these market participants has implications for the functioning of financial markets. Strategic trading may produce significant price distortions, increase price manipulation, and trigger forced liquidations of large traders.