[We examine the design of control rights of external financiers, and how these interact with the firm's security issuance and capital structure when the firm's initial owners and managers may disagree with new investors over project choice. The first main result is an ex ante managerial preference for "soft" financial claims that maximize managerial projectchoice autonomy, which is in contrast to agency theory. Second, a dynamic "pecking order" of cash, equity, and debt emerges. Additional results explain equity issuance at high prices, the drifting of leverage ratios with stock returns, cash hoarding, and debt usage without taxes, agency, or signaling.]

In this article we ask: what kind of information and how much of it should firms voluntarily disclose? Three types of disclosures are considered. One is information that complements the information available only to informed investors (to-be-processed complementary information). The second is information that is orthogonal to that which any investor can acquire and thus complements the information available to all investors (preprocessed complementary information). And the third is information that substitutes for the information of the informed investors in that it reveals to all what was previously known only by the informed (substitute information). Our main results are as follows. First, in equilibrium, all types of firms voluntarily disclose all three types of information. Second, in contrast to the existing literature, complementary information disclosure by firms strengthens investors' private incentives to acquire information. Substitute information disclosure weakens private information acquisition incentives. Third, while complementary information disclosure has an ambiguous effect on financial innovation incentives, substitute information disclosure weakens those incentives.

[We explore the implications of financial system design for financial innovation. We begin with assumptions about the investment opportunities of firms, their observable attributes, and the roles of commercial banks, investment banks, and the financial market. We examine the borrower's choice between bank and financial market funding, the commercial bank's choice of monitoring capacity, and the investment bank's choice of whether to invest in financial innovation. Our main result is that financial innovation in a universal banking system is stochastically lower than innovation in a financial system in which commercial and investment banks are functionally separated.]

This article builds a theory of financial system architecture. We ask: what is a financial market, what is a bank, and what determines the economic role of each? Starting with basic assumptions about primitives–the types of agents and the nature of informational asymmetries–we provide a theory that explains which agents coalesce to form banks and which trade in the capital market. It is shown that borrowers of higher observable qualities access the financial market. Moreover, a financial system in its infancy will be bank-dominated, and increased financial market sophistication diminishes bank lending.

In this article, we provide a novel rationale for credit ratings. The rationale that we propose is that credit ratings serve as a coordinating mechanism in situations where multiple equilibria can obtain. We show that credit ratings provide a "focal point" for firms and their investors, and explore the vital, but previously overlooked implicit contractual relationship between a credit rating agency (CRA) and a firm through its credit watch procedures. Credit ratings can help fix the desired equilibrium and as such play an economically meaningful role. Our model provides several empirical predictions and insights regarding the expected price impact of rating changes.

We examine the design of control rights of external financiers, and how these interact with the firm's security issuance and capital structure when the firm's initial owners and managers may disagree with new investors over project choice. The first main result is an ex ante managerial preference for “soft” financial claims that maximize managerial project-choice autonomy, which is in contrast to agency theory. Second, a dynamic “pecking order” of cash, equity, and debt emerges. Additional results explain equity issuance at high prices, the drifting of leverage ratios with stock returns, cash hoarding, and debt usage without taxes, agency, or signaling.

In this article we ask: what kind of information and how much of it should firms voluntarily disclose? Three types of disclosures are considered. One is information that complements the information available only to informed investors (to-be-processed complementary information). The second is information that is orthogonal to that which any investor can acquire and thus complements the information available to all investors (preprocessed complementary information). And the third is information that substitutes for the information of the informed investors in that it reveals to all what was previously known only by the informed (substitute information). Our main results are as follows. First, in equilibrium, all types of firms voluntarily disclose all three types of information. Second, in contrast to the existing literature, complementary information disclosure by firms strengthens investors’ private incentives to acquire information. Substitute information disclosure weakens private information acquisition incentives. Third, while complementary information disclosure has an ambiguous effect on financial innovation incentives, substitute information disclosure weakens those incentives.

This article builds a theory of financial system architecture. We ask: what is a financial market, what is a bank, and what determines the economic role of each? Starting with basic assumptions about primitives—the types of agents and the nature of informational asymmetries—we provide a theory that explains which agents coalesce to form banks and which trade in the capital market. It is shown that borrowers of higher observable qualities access the financial market. Moreover, a financial system in its infancy will be bank-dominated, and increased financial market sophistication diminishes bank lending.

In this article, we provide a novel rationale for credit ratings. The rationale that we propose is that credit ratings serve as a coordinating mechanism in situations where multiple equilibria can obtain. We show that credit ratings provide a “focal point” for firms and their investors, and explore the vital, but previously overlooked implicit contractual relationship between a credit rating agency (CRA) and a firm through its credit watch procedures. Credit ratings can help fix the desired equilibrium and as such play an economically meaningful role. Our model provides several empirical predictions and insights regarding the expected price impact of rating changes.