Private information obtained by lenders leads to borrower capture to the extent that such information cannot be communicated credibly to outsiders. We analyze how this capture affects the loan portfolio allocation of informed lenders. First, we show that banks charge higher interest rates and finance relatively less creditworthy borrowers in market segments with greater information asymmetries. Second, when faced with greater competition from outside lenders, banks reallocate credit toward more captured borrowers (flight to captivity). Third, if borrower quality and captivity are sufficiently correlated, an increase in the competitiveness of uninformed lenders can worsen the informed lender's overall loan portfolio. The model explains observed consequences of financial liberalizations.

Loan guarantees represent a form of government intervention to support bank lending. However, their use raises concerns as to their effect on bank risk-taking incentives. In a model of financial fragility that incorporates bank capital and a bank incentive problem, we show that loan guarantees reduce depositor runs and improve bank underwriting standards, except for the most poorly capitalized banks. We highlight a novel feedback effect between banks’ underwriting choices and depositors’ run decisions, and show that the effect of loan guarantees on banks’ incentives is different from that of other types of guarantees, such as deposit insurance.

Many acquisitions are conducted by clubs, i.e., coalitions of acquirers that submit a single bid. We present a novel analysis of club bidding where the club creates value by aggregating, at least partially, bidders' values. We show that club formation can lead to higher acquisition prices when the number of bidders is exogenously fixed and large. However, when entry costs require bidders to optimize their participation decisions, club formation acts as an endogenous limit on competition and reduces the target's premium. In contrast, social efficiency with club bidding is always higher. Our findings can reconcile the contradictory evidence on club bidding.

We present a general equilibrium model of banks’ optimal capital structure where bankruptcy is costly and investors have heterogeneous endowments and incur a cost for participating in equity markets. We show that, besides its social benefits, capital regulation benefits bank shareholders when it resolves fire sales externalities but not when it acts as a tax on bank profits such as when used to control excessive leverage induced by deposit insurance. Furthermore, capital regulation widens the gap between the returns to bank shareholders and depositors and may reduce investments in projects in favor of storage.

In a model with bankruptcy costs and segmented deposit and equity markets, we endogenize the cost of equity and deposit finance for banks. Despite risk neutrality, equity capital earns a higher expected return than direct investment in risky assets. Banks hold positive capital to reduce bankruptcy costs, but there is a role for capital regulation when deposits are insured. Banks could no longer use capital when they lend to firms instead of investing directly in risky assets. This depends on whether the firms are public and compete with banks for equity capital or are private with exogenous amounts of capital.