[A firm must decide what security to sell to raise external capital to finance a profitable investment opportunity. There is ex ante asymmetry of information regarding the probability distribution of cash flow generated by the investment. In this setting, we derive necessary and sufficient conditions for a security to be optimal (uniquely optimal), that is, for pooling at this security to be an (the unique) equilibrium outcome. Using these conditions we show that the debt contract is (uniquely) optimal if and only if cash flows are ordered by (strict) conditional stochastic dominance. Finally, we derive an equivalence relationship between optimal security designs and designs that minimize mispricing.]

We model the agency relationship between managers and investors. Through socialization, ethical managers develop internalized norms which prevent them from acting opportunistically. Unethical managers lack these norms. Higher ethical standards on the part of managers increase economic activity in the short run. However, increased economic activity increases opportunities to profit from unethical behavior, eroding ethical standards over the long run. When this rate of erosion is high, cycling of ethics and economic activity emerges. Otherwise, ethics and economic activity converge to a stable long-run limiting value.

A firm must decide what security to sell to raise external capital to finance a profitable investment opportunity. There is ex ante asymmetry of information regarding the probability distribution of cash flow generated by the investment. In this setting, we derive necessary and sufficient conditions for a security to be optimal (uniquely optimal), that is, for pooling at this security to be an (the unique) equilibrium outcome. Using these conditions we show that the debt contract is (uniquely) optimal if and only if cash flows are ordered by (strict) conditional stochastic dominance. Finally, we derive an equivalence relationship between optimal security designs and designs that minimize mispricing.