We present a theory of capital structure based on the power of shareholders, bondholders and managers to control the incentive conflicts in large corporations. The manager–owner conflict produces a trade-off between inefficiency in the low state and rents in the high state, and the shareholder–bondholder conflict produces under-investment as in Myers [Journal of Financial Economics 19 (1997) 147]. Since managers and bondholders both prefer more efficient actions in the low state, the two conflicts are interdependent. With risk-less levels of debt, there are no shareholder–bondholder agency costs, but managerial control over the incentive-setting process produces excessive rents. With risky debt, shareholders focus more on returns in the high state so that shareholder–bondholder agency costs increase but managerial rents decrease. Efficient levels of debt holder protection facilitate a reduction in manager–owner agency costs that outweighs shareholder–bondholder agency costs, and are decreasing in firm performance. The results are consistent with the separate empirical results relating control to both compensation and leverage, and suggest how future studies can be integrated.

Taylor's model of staggered contracts is an influential explanation for nominal inertia and the persistent real effects of nominal shocks. However, in standard imperfect competition models, if agents are allowed to choose the timing of pricing decisions, they will typically choose to synchronize. This paper provides a simple model of imperfect competition which produces stable staggering. Our argument relies on strategic interaction at two levels—between firms within an industries, and across industries—and produces a continuum of staggered price equilibria. These equilibria are strict, and hence stable under a simple adaptive learning process.

The central puzzle in international business cycles is that fluctuations in real exchange rates are volatile and persistent. We quantify the popular story for real exchange rate fluctuations: they are generated by monetary shocks interacting with sticky goods prices. If prices are held fixed for at least one year, risk aversion is high, and preferences are separable in leisure, then real exchange rates generated by the model are as volatile as in the data and quite persistent, but less so than in the data. The main discrepancy between the model and the data, the consumption—real exchange rate anomaly, is that the model generates a high correlation between real exchange rates and the ratio of consumption across countries, while the data show no clear pattern between these variables.

An important characteristic of any buyer‐supplier relationship is the amount and type of information that is exchanged between the contracting parties. Buyer‐supplier networks are characterized by greater information exchange than arm’s‐length transactions. This enhanced information exchange allows for greater production efficiency but increases the potential for information misappropriation. In this paper we characterize the set of innovations for which each of these forms of exchange relationships is efficient. We then explore the effect of an initial information linkage between the buyer and supplier. Such linkages increase the set of innovations for which networks are efficient. However, such linkages have a negative effect on the buyer’s incentive to innovate and an ambiguous effect on the supplier’s incentive to invest in flexible production techniques. Finally, we identify settings in which the buyer‐supplier surplus is greater with such linkages.

This paper analyzes corporate bond valuation and optimal call and default rules when interest rates and firm value are stochastic. It then uses the results to explain the dynamics of hedging. Bankruptcy rules are important determinants of corporate bond sensitivity to interest rates and firm value. Although endogenous and exogenous bankruptcy models can be calibrated to produce the same prices, they can have very different hedging implications. We show that empirical results on the relation between corporate spreads and Treasury rates provide evidence on duration, and we find that the endogenous model explains the empirical patterns better than do typical exogenous models.