Are adverse selection models of debt robust to changes in market structure?
No 28/2003, Research Discussion Papers from Bank of Finland Abstract: Many adverse selection models of standard one-period debt contracts are based on the following seemingly innocuous assumptions. First, entrepreneurs have private information about the quality of their return distributions. Second, return distributions are ordered by the monotone likelihood-ratio property. Third, financiers’ payoff functions are restricted to be monotonically non-decreasing in firm profits. Fourth, financial markets are competitive. We argue that debt is not an optimal contract in these models if there is only one (monopoly) financier rather than an infinite number of competitive financiers. Keywords: security design; adverse selection; monotonic contracts; monotone likelihood ratio; first-order stochastic dominance (search for similar items in EconPapers) JEL-codes: D82 G35 (search for similar items in EconPapers) Date: 2003-11-11 View list of references Downloads: (external link) http://www.bof.fi/N
