A Fast Literature Search Engine based on top-quality journals, by Dr. Mingze Gao.

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  • This paper analyzes a dynamic lending relationship where the borrowercannot be forced to make repayments, and the lender offerslong-term contracts that are imperfectly enforced and repeatedlyrenegotiated. No commitment and full commitment by the lenderare special cases of this model where the probability of enforcementequals zero and one, respectively. I show that an increase inthe degree of enforcement can lower social welfare. Furthermore,properties of equilibrium investment dynamics with partial commitmentdrastically differ from those with full and no commitment. Inparticular, investment is positively related to cash flow, consistentwith empirical findings.

  • We analyze a model where investors use a credit rating to decide whether to finance a firm. The rating quality depends on unobservable effort exerted by a credit rating agency (CRA). We study optimal compensation schemes for the CRA when a planner, the firm, or investors order the rating. Rating errors are larger when the firm orders it than when investors do (and both produce larger errors than is socially optimal). Investors overuse ratings relative to the firm or planner. A trade-off in providing time-consistent incentives embedded in the optimal compensation structure makes the CRA slow to acknowledge mistakes.

  • We propose a tractable model of asset management in which benchmarking arises endogenously, and analyze its welfare consequences. Fund managers' portfolios are not contractible and they incur private costs in running them. Incentive contracts for fund managers create a pecuniary externality through their effect on asset prices. Benchmarking inflates asset prices and creates crowded trades. The crowding reduces the effectiveness of benchmarking in incentive contracts for others, which fund investors fail to account for. A social planner, recognizing the crowding, opts for contracts with less benchmarking and less incentive provision. The planner also delivers lower asset management costs.

  • We argue that the pervasive practice of evaluating portfolio managers relative to a benchmark has real effects. Benchmarking generates additional, inelastic demand for assets inside the benchmark. This leads to a “benchmark inclusion subsidy:” a firm inside the benchmark values an investment project more than the one outside. The same wedge arises for valuing M&A, spinoffs, and IPOs. This overturns the proposition that an investment’s value is independent of the entity considering it. We describe the characteristics that determine the subsidy, quantify its size (which could be large), and identify empirical work supporting our model’s predictions.

Last update from database: 5/23/24, 11:00 PM (AEST)