Financing and Taxing New Firms under Asymmetric Information

Robin Boadway and Michael Keen

FinanzArchiv: Public Finance Analysis, 2006, vol. 62, issue 4, 471-502

Abstract: This paper uses a sequence of models to study the efficiency of credit-market equilibria, and the scope for welfare-improving policy interventions, when financial intermediaries cannot observe the riskiness or returns of potential investment projects by new firms. It is first shown that when only loan financing is available there is a systematic tendency towards overinvestment in high-return, high-risk projects and underinvestment in low-return, low-risk projectsrelative to the social optimum [this encompasses the well-known results of Stiglitz and Weiss (1981) and de Meza and Webb (1987) as special cases]. The ambiguity is mitigated, however, if firms have access to equity financing: there is then (under reasonable conditions) unambiguously overinvestment. Policy implications are developed, and the results extended to allow for screening and signaling equilibria.

Keywords: credit markets; asymmetric information (search for similar items in EconPapers)
JEL-codes: G14 G18 (search for similar items in EconPapers)
Date: 2006
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Citations: View citations in EconPapers (31)

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DOI: 10.1628/001522106X172661

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