We study privatization under moral hazard and adverse selection. We show that if the fraction of efficient investors is either insignificant or productivity differences between efficient and inefficient investors are negligible, the government would offer a pooling contract and sell the same fraction of equity to both types of investors. The lower the productivity difference, the greater the equity stake offered to investors. On the other hand, if the fraction of efficient investors is significant or productivity differentials are large, the optimal policy consists of a dual method of privatization in which it offers two methods of privatization to outside investors. The first method consists of a sale of 100% equity together with a subsidy and charges higher price. Under the second option, the investor pays a smaller price but buys less than 100% equity without any subsidy. Efficient investors opt for the first method while inefficient investors prefer the second. The dual privatization method screens investors and provides them with maximum incentives to invest while minimizing the risk of post-privatization bankruptcy.

We investigate the capital structure of pioneering startup firms, which are frequently credited with opening new markets and niches in the digital era and often face the threat of the potential entry of successful, cash-rich firms from adjacent markets. Our analysis is made in the context of a winner-take-all competition in the form of an all-pay auction for the monopolistic position in a new market. We show that a pioneer's optimal capital structure exhibits widespread diversity and is determined by a tradeoff between entry deterrence and post-entry competition intensification. A pure-equity (a mixture of equity and risky debt) structure is optimal when (1) barriers to entry are small (large), (2) the future prospect of the new market is fairly certain and/or, (3) the new market is likely (unlikely) to create large externalities on the potential entrant's existing business. The post-entry competition is likely to engender large losses to both the winner and the loser.

ABSTRACT We provide a theory of informal communication—cheap talk—between firms and capital markets that incorporates the role of agency conflicts between managers and shareholders. The analysis suggests that a policy of discretionary disclosure that encourages managers to attract the market's attention when the firm is substantially undervalued can create shareholder value. The theory also relates the credibility of managerial announcements to the use of stock‐based compensation, the presence of informed trading, and the liquidity of the stock. Our results are consistent with the existence of positive announcement effects produced by apparently innocuous corporate events (e.g., stock dividends, name changes).

The paper shows that politically motivated interventions in the financial market in the form of bailing out borrowing firms reduce banks' incentives to gather valuable information about firms' projects. This loss of information is a hidden cost which adversely affects firm value. Firms invest resources and pay a premium to politically connected persons (BOD or other personnel). Such connections serve the twin purposes of hedging and enhancement of the value of collateral pledged against bank loans. Feeling secured, banks lose incentives to monitor borrowing firms. Thus, wealth effect of bailout from political connection is partially offset by the losses of valuable information brought about by bank lending. In equilibrium, the trade-off from gains out of political connections and costs due to losses from information-based bank monitoring depend on (i) the country's disclosure laws, (ii) the political environment, (iii) the premium paid to form connections, and (iv) the state of the economy.

We explore the impact of strategic behaviour of equity holders, debt holders and an opportunistic supplier of a critical input on the firm's capital structure, organisational design, and its outsourcing decision. We show that the supplier can trigger strategic bankruptcy even when the firm is solvent. Equity holders respond to this either by eliminating the supplier and producing the input in-house or by reducing their exposure to debt by using equity-financing. Both responses introduce inefficiency since input costs are higher with in-house production, and debt is cheaper than equity. We show that the equilibrium debt-equity ratio varies positively with cash-flow profitability and the marginal cost of the supplier's input, but negatively with the riskiness of the cash flow and the equity holders' in-house input production costs.