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.

Venture capital financing is characterized by extensive use of convertible securities and stage financing. In a model where a venture capitalist provides staged financing for a project, we illustrate an advantage of convertible debt (or warrants) over a mixture of debt and equity. Essentially, when the venture capitalist retains the option to abandon the project, the entrepreneur has an incentive to engage in window dressing and bias positively the short-term performance of the project, reducing the probability that it will be liquidated. An appropriately designed convertible security prevents such behaviour because window dressing also increases the probability that the venture capitalist will exercise the conversion option becoming the owner of a substantial fraction of the project's equity.

Using standard Industrial Organization tools, we analyze the relation between competition in arm's length financial markets and the prevalence of close bank-firms ties. We show how the degree of competition between financial intermediaries affects the intensity of relationships between banks and client firms, and explore the idea that investment in bank-firm relationships can be used strategically by incumbent multi-product (universal) banks to limit competition in arm's length markets. The analysis implies that reforms designed to facilitate entry of new intermediaries may actually induce incumbent banks to increase investment in relationship banking, so that regulatory entry barriers are replaced by entry barriers created endogenously, namely, there is “path dependence” in the market structure of financial systems. This result suggests that increased (potential) competition in the financial services industry will not always destroy bank-firm relationships but, on the contrary, may actually strengthen them.

State‐level consumption exhibits excess sensitivity to lagged income to the same extent as U.S. aggregate data, but state‐specific (idiosyncratic) consumption exhibits substantially less sensitivity to lagged state‐specific income—a result that also holds for Canadian provinces. We propose the following interpretation: borrowing and lending in response to changes in consumer demand are easier for individual U.S. states than for the United States as a whole, and therefore, the measured deviation from the benchmark permanent income hypothesis model is smaller. However, lagged state‐specific variables help predict state‐specific consumption, suggesting that the PIH model still requires qualification.

Risk Sharing and Industrial Specialization: Regional and International Evidence by Sebnem Kalemli-Ozcan, Bent E. Sørensen and Oved Yosha. Published in volume 93, issue 3, pages 903-918 of American Economic Review, June 2003

The magnitude and the direction of net international capital flows do not fit neoclassical models. The fifty U.S. states comprise an integrated capital market with very low barriers to capital flows, which makes them an ideal testing ground for neoclassical models. We develop a simple frictionless open economy model with perfectly diversified ownership of capital and find that capital flows among the states are consistent with the model. Therefore, the small size and “wrong” direction of net international capital flows are likely due to frictions associated with national borders, not to inherent flaws in the neoclassical model.