Knowledge that Transforms

We examine the financing and insurance policies of a firm with private information regarding its operating cash flows and insurance risk. When its insurable losses are small, the firm chooses either self-insurance or full insurance. It chooses self-insurance, it may display a preference for equity financing. However, if it chooses full insurance, it prefers debt financing. When the firm′s insurable losses are large, its insurance and financing decisions can signal its private information. While both debt and equity complement insurance decisions in signaling private information, debt facilitates signaling favorable information for a larger set of parameters. Journal of Economic Literature Classification Numbers: D82, G22, G32.

This paper examines the form of futures contracts which a monopolistic exchange will offer to maximise transaction revenue when transaction fees are endogenously determined. We establish the desirable characteristics of participants in contracts. For example, we show that contracts which appeal to hedgers on one side of the market and to speculators on the other are desirable. In contrast to earlier work, we show that the sequentially selected set of contracts may not be optimal. It may be desirable for the exchange to offer correlated contracts, or even to bundle several contracts together and sell the bundled contract at a fee lower than the fee charged for the set of contracts purchased separately. Journal of Economic Literature Classification Numbers: G13, G20.

This paper considers a standard monetary economy with indivisible primary assets and transaction costs. When assets are indivisible, if a steady-state equilibrium with positive savings exists, there necessarily exists a very large set of equilibria. The intermediation of indivisible assets substantially reduces the set of competitive equilibria, and enhances the "flexibility" of prices. We state sufficient conditions for intermediaries to form and hold all primary assets directly. We define and analyze various measures of the consumer surplus created by intermediaries. We show that conventional measures of intermediary output bear no obvious relation to the consumer surplus created by intermediation. Journal of Economic Literature Classification Numbers: E40, G20.

Small- and medium-size, high quality, entrepreneurial firms may prefer bilateral to multilateral financing arrangements, in order to avoid disclosure of private information which might leak to competitors. In the presence of a cost differential between these forms of financing, the higher quality firms (those with more to lose from disclosure) prefer bilateral financing. The cost differential prevents competitors from unambiguously inferring that these firms are hiding information. Journal of Economic Literature Classification Numbers: D82, G21, G32, K22.

There is a common perception that many firms issue convertible debt as a form of delayed equity. The advantage of issuing equity in this delayed manner has been linked to the lower adverse selection properties of convertible debt as compared to equity; one can first issue convertibles and later call, forcing conversion, presumably preserving the initial advantage of the convertibles. However, this paper suggests that the benefits of callable convertible debt as delayed equity are preserved only if conversion is voluntary. This appears to be consistent with the empirical evidence. Journal of Economic Literature Classification Numbers: G32, D82.

This paper investigates the relationship between a firm′s loan commitment demand and its overall capital structure. I develop a model which demonstrates that a loan commitment leads a firm to higher privately optimal debt level and a lower cost of debt funds; these results are driven by the loan commitment′s ability to attenuate the potential moral hazard problems attendant upon debt financing. I confront the predictions with cross-sectional data, and find that the availability of unused loan commitment financing is positively related to firm leverage and negatively related to cost of debt funds. Journal of Economic Literature Classification Numbers: D82, G21, G32.

Investment advisory firms and brokerage firms hire analysts to uncover profitable securities investment opportunities. Then these firms sell the information (either directly or indirectly) to others. Why? Given that the information has value, why do these firms not keep the information to themselves and trade solely for their own accounts? Because of competition, information is more valuable when fewer people trade on the information. This paper shows that selling information is a strategic response by competing informed traders. Specifically, it is a means for informed traders to commit to trade aggressively, thereby inducing other informed traders to trade less aggressively. Journal of Economic Literature Classification Numbers: G10, D82.