direct revelation versus signalling an entrepreneur wishes to communicate private information to investors to secure a desirable financial contract the entrepreneur can signal project type through its choice of capital structure or can directly reveal sufficient information so that its type is known information directly revealed is observed by a rival who may enter and appropriate some of the project s rents conditions under which either of these communication policies are chosen are determined when local incentive compatibility is sufficient for global incentive compatibility the authors show that each type either reveals just enough information to credibly communicate its type or instead reveals no information and signals

debt futures and options optimal price linked financial contracts under moral hazard and limited liability this paper characterizes the optimal financial contract between a risk neutral entrepreneur and risk neutral lender investors when the entrepreneur has limited liability there is moral hazard and the investor payoff function can depend on both output and output price but is nondecreasing in output in this setting the optimal contract is a price contingent commodity bond that can be replicated by combining pure debt commodity futures and commodity call option contracts although a pure commodity bond contract is sometimes optimal a pure debt contract is almost never optimal various properties of the entrepreneur s optimal price contingent promised payment are described copyright 1993 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

a note on discount rate policy and the variability of discount window borrowing abstract the purpose of this note is to evaluate the appropriate discount rate policy rules consistent with minimization of the variability of borrowing at the federal reserve discount window in the context of goodfriend s 1983 model of the bank borrowing decision it is demonstrated that either a penalty rate or a subsidy rate policy will produce minimized variability of borrowing so long as the subsidy rate adjusts point for point to changes in the value of the federal funds rate these policy rules are compatible with a policy procedure designed to target borrowed or non borrowed reserves if the fed does not adhere to one of these specific rules minimization of borrowing variability requires an open market procedure in which the fed pegs the federal funds rate

strategic financial signalling abstract in an entry game the entrant and financial markets are uninformed about the incumbent s costs the entrant wishes to enter the market if and only if the incumbent has high costs therefore a low cost incumbent would like to signal its cost to the entrant to deter its entry simultaneously it would like to reveal its private information to financiers to obtain actuarially fair financial prices we suggest that financial structure may act as a common signal in financial and output markets in equilibrium a low cost incumbent s highly leveraged financial stucture becomes an effective entry deterrent as it reveals private information to the entrant and financiers

corporate debt and output pricing in developing countries industry level evidence from turkey abstract the present study is an application of capital structure theory to developing economies where markets are commonly imperfect the industry level data of turkey is used as a benchmark case to investigate the effects of corporate debt on output pricing which in return might have critical implications for stabilization theory the panel estimations on the major two digit industries reveal two basic findings first short term debt leads to an increase in output prices while long term debt has the opposite effect and short term but not long term debt has a cyclical influence on prices second the inflationary effect short term debt implies a lower capital gain and induces higher prices while the effect long term debt implies a higher capital gain and induces lower prices given the predominant share of short term debt in most developing countries these findings suggest an explanation for inflation inertia on the side of corporate sector

viewpoint canadian competition policy progress and prospects this paper discusses the state of competition policy in particular the economics of competition policy in canada today and considers its prospects going forward it argues that i the importance of competition policy has become accepted widely in canada and indeed throughout much of the world ii competition policy design and enforcement is in general well done in canada iii economists including many canadians have played a central role in the development of an efficient and effective competition policy in canada and elsewhere and iv competition policy in canada is today facing very serious challenges and economists should be concerned la politique de concurrence au canada progres et prospective ce memoire discute de l etat de la politique de concurrence en particulier l economie de la politique de concurrence au canada aujourd hui et examine ce qui l attend on suggere que i l importance de la politique de concurrence est devenue largement acceptee au canada et dans le gros du reste du monde ii le dessein et l application de la politique de concurrence sont en general bien faits au canada iii les economistes et plusieurs canadiens parmi eux ont joue un role central dans le developpement d une politique de concurrence efficace et effective au canada et ailleurs et iv la politique de concurrence au canada fait face a des defis tres serieux ces temps ci et les economistes devraient s en inquieter

the collapse of purchasing power parities during the 1970 s one of the striking facts concerning the relationship beiveen prices and exchange rates during the 1970 s has been the dismal performance of the predictions of the simple versions of the purchasing power parity doctrine ppp that doctrine in its absolute version states that the equilibrium exchange rate between domestic and foreign currencies equals the ratio of domestic to foreign price levels the relative version of the doctrine relates equilibrium changes in exchange rates to changes in the ratio of domestic to foreign prices during the 1970 s short run changes in exchange rates bore little relationship to short run differentials in national inflation rates and frequently divergences from purchasing power parities have been cumulative this paper reviews and analyzes the empirical record of exchange rates and prices during the 1970 s and the analysis is based on the experience of the dollar pound the dollar frecch franc and the dollar dm exchange rates section 2 presents the evidence on ppp during the 1970 s and contrasts it with the evidence from the 1920 s a period during which the doctrine held up reasonably well this analysis is relevant for assessing whether the flexible exchange rate system was successful in providing national economies with an added degree of insulation from foreign shocks and whether it provided policymakers with an added instrument for the conduct of macroeconomic policy the evidence regarding devia tions from purchasing power parities is also relevant for determining whether there is a case for managed float section 3 attempts to explain what went wrong with

innovation and investment under financial constraints and product market competition abstract the present paper extends previous work on predatory behavior against financially constrained firms e g bolton and scharfstein 1990 to include innovation and product market competition i show that the pattern of strategic interaction between competing firms determines behavioral changes coming from financial constraints both leveraged and unleveraged firms react to financial constraints the theory is used to explain recent empirical findings concerning the interaction of capital market imperfections and market structure

unit roots and the real exchange rate before world war i the case of britain and the usa abstract unit root and cointegration tests indicate that the dollar pound real exchange rate was stationary during the us greenback and gold standard periods purchasing powwer parity ppp performed about equally well in the two periods and better than in recent years deviations from ppp were corrected by changes in british prices and us gold dollar prices greenback prices did not adjust the similarity of the adjustment parameters in the two periods suggests that expectations of a return to gold were embedded in the greenback price of gold

financial signalling and the deep pocket argument this article provides a formal representation of telser s 1966 deep pocket argument by considering a model in which the entrant s and the incumbent s financial structures are endogenous the entrant s financial vulnerability may be explained by informational asymmetries in financial markets financiers are uncertain of the entrant s true value but they know the incumbent s true worth both firms have to finance a fixed expenditure before starting production in equilibrium the incumbent finances with equity while the high value entrant comes into the market heavily leveraged compared with the incumbent this provides an incentive for the incumbent to engage in predatory practices such as a price war to exhaust the entrant financially and cause his bankruptcy

real and nominal shocks in a two country price setting world abstract this paper develops a two country model in which the law of one price does not hold in the short run and which is consistent with the stylized fact that exchange rates respond more quickly to news than prices this is done by assuming that firms face lumpy information costs in determining what price to charge both domestic and imported goods prices are therefore sticky with respect to news and deviations from the law of one price ppp are due to exchange rate surprises the model is used to analyze the domestic and international impact of real and nominal disturbances

anticompetitive financial contracting the design of financial claims this paper presents the first model where entry deterrence takes place through financial rather than product market channels in standard models of the interaction between product and financial markets a firm s use of financial instruments deters entry by affecting product market behavior whereas in our model entry deterrence occurs by affecting the credit market behavior of investors towards entrant firms we find that in order to deter entry the claims held on incumbent firms should be sufficiently risky i e equity in contrast to the standard branderlewis 1986 result that debt deters entry the model sheds light on the policy debate on the separation of banking as to whether banks should be permitted to hold equity in firms it also provides an explanation for why venture capitalists hold automatically convertible securities in start up firms

commercial bank refinancing and economic stability an analysis of european features abstract this paper investigates the effect of two types of central bank advances viz lombarding and rediscounting on the economy we conclude that the root of the distinction is the differential collateralization of these two forms of advances the results suggest that while both methods of refinancing reduce interest rate movement rediscounting dampens the impact of base money and real sector disturbances debt equity shifts have greater price effects with rediscounting than with lombarding the paper also investigates the effects of a pegged rate pricing policy it is shown that a pegged rate policy is an intermediary between fixed and market rate regimes

capital structure and output pricing in a developing country this paper uses the industry level data to investigate the effects of corporate debt on output pricing in a typical developing country the panel estimations on the major two digit industries reveal two basic findings first short term debt leads to an increase in output prices while long term debt has the opposite effect second short term debt but not long term debt is found to have cyclical effects on prices

a general equilibrium money and banking paradigm in this paper we propose and analyze a new paradigm for monetary analysis that is considerably richer than the standard money multiplier models found in the literature a general equilibrium approach to financial assets is developed that leads directly to a multiplier system that transcends the traditional dependence on demand deposits and is easily amenable to exposition and manipulation the model incorporates financial innovation and regulatory changes easily and allows for the general equilibrium effects of the variation in financial ratios that result from induced movements in income interest rates or prices the current analysis differs from traditional multiplier presentations in two distinct ways first the traditional approach to monetary expansion and multiplier analysis relies upon the ratios of various financial assets to demand deposits over the last decade decreased financial regulation and subsequent innovation have substantially changed the nature of depository institution liabilities and their substitutability with demand deposits this has led to the reduction in emphasis on demand deposits per se and an increasing dependence upon transaction accounts other than demand deposits thrift institutions now accounts automatic transfer accounts and overdrafts money market mutual funds and overnight repurchase agreements have made the dependence on demand deposits as a basis for multiplier analysis somewhat obsolete and artificial the model developed here can accommodate any number of transaction assets by specifying general asset demand ratios relative to total household wealth the second and more fundamental way in which our model differs from existing ones is the way in which it weds general equilibrium considerations with simple multiplier analysis the traditional approach to multipliers is to assume that any ratio between two financial assets vying for a role in the aggregate wealth portfolio is exogenous and invariant to other variables in today s economy this seems rather inappropriate any regulatory or asset preference change will result in changes in the endogenous variables in the economy which will further impact financial demands the exogeneity of asset preferences and reserve ratios is no

on the strategic role of high leverage in entry deterrence abstract this paper examines the strategic role of high levels of debt and bankruptcy threats in deterring entry into monopolistic markets in the context of an infinite horizon entry game we show that if a potential entrant has access to debt financing with limited liability the unique sub game perfect equilibrium involves the entrant successfully issuing a high level of debt entering the market and being met with cooperation if in addition to the entrant the incumbent also has access to debt with limited liability it will be highly levered and will completely pre empt any entry in equilibrium finally if the incumbent faces a variety of potential entrants with differing abilities to capture market shares its optimal capital structure will help pre empt the entry of the tougher entrants while allowing the weaker ones to share the market the results of extreme leverage are also shown to hold in an alternative formulation analyzed by kreps and wilson 1982 and milgrom and roberts 1982 and thus are robust to model specifications the empirical implications and possible application to high leverage industries are briefly discussed

exchange rate dynamics an empirical investigation this paper estimates a reduced form exchange rate equation whose estimates are used to address questions on exchange rate overshooting intermediate run exchange rate dynamics and long run proportionality relationships between relative money supplies and exchange rates based on swiss u s data from the period 1973 79 the major findings are that following a monetary shock there is short run exchange rate overshooting by a factor of about two and that subsequent exchange rate adjustments to a new long run equilibrium take longer than 2 years and exhibit nonmonotonic patterns

debt investment and product market competition a note on the limited liability effect abstract this paper extends a model by brander and lewis brander j lewis t 1986 oligopoly and financial structure the limited liability effect american economic review 76 956 970 on the relationship between capital structure investment and product market competition based on the limited liability effect of debt empirical papers see for example campello campello m 2003 capital structure and product markets interactions evidence from business cycles journal of financial economics 68 353 378 and chevalier chevalier j 1995a capital structure and product market competition empirical evidence from the supermarket industry american economic review 85 415 435 chevalier j 1995b do lbo supermarkets charge more an empirical analysis of the effect of lbos on supermarket pricing journal of finance 50 1095 1112 generally reject the limited liability theories in favor of the predatory theories because leverage leads to less investment and weaker product market competition this paper shows that when firms also have an investment choice leverage can lead to weaker product market competition in a limited liability model in addition non zero leverage is still optimal within this model based solely on the limited liability effect in predatory models debt is motivated by issues outside of product market concerns for example to solve an agency problem finally this model is also consistent with the investment decisions documented empirically

asset returns discount rate changes and market efficiency the primary purpose of this paper is to reconcile the previous findings of discount rate endogeneity with the presence of discount rate announcement effects in securities markets the crux of this reconciliation is the distinction between technical discount rate changes that are endogenous and nontechnical changes which contain some informative policy implications in essence we attempt to separate expected discount rate changes from unexpected changes or equivalently the expected component of discount rate changes from the unexpected component if markets are efficient the former should have no announcement effects while the latter may be associated with an announcement effect accordingly the focus of the empirical analysis is on the interaction between discount rate exogeneity the specific monetary policy regime and accouncement effects in addition we examine whether the behavior of these markets in the postannouncement period is consistent with the rapid price adjustment implied by market efficiency

when does predation dominate collusion i study repeated competition among oligopolists the only novelty is that firms may go bankrupt and permanently exit the probability that a firm survives a price war depends on its financial strength which varies stochastically over time under some conditions including no entry an anti folk theorem holds when firms are patient so that strength levels change relatively quickly every nash equilibrium involves an immediate price war that lasts until at most one firm remains surprisingly the possibility of entry may facilitate collusion as may impatience the model can explain some observed patterns of collusion and predation

strategic entry deterrence in analyzing deterrence of large scale entry two classes of entry barriers may be distinguished an innocent entry barrier is unintentionally erected as a side effect of innocent profit maximization in contrast a strategic entry barrier is purposely erected to reduce the possibility of entry two types of innocent barriers may also be distinguished a postentry absolute advantage has the property that if entry did occur the established firm would be at a profit advantage over the entrant examples are superior technology or product design patents and lower input prices a preentry asymmetry advantage arises from the fundamental preentry asymmetry between established firm and potential entrant before the entrant makes his entry decision the established firm has already committed resources this prior existence gives first move advantages the preentry asymmetry is independent of symmetry or asymmetry in the rules the equilibrium concept of the postentry game that might ensue even if the postentry game will be played according to nash cournot or entrant as leader rules the preentry leadership

sticky prices and purchasing power parity deviations empirical implications abstract this note tests one implication of the hypothesis that purchasing power parity ppp deviations are partly caused by different pricing behavior in goods and asset markets cross country regressions of the variance of ppp deviations on the variance of money supply innovations support the hypothesis

the impact of debt financing on entry and exit in a duopoly this article investigates the interaction between market entry company foreclosure and capital structure in a duopoly we find that the order in which firms foreclose is determined not only by differences in firm specific factors but also by common economic factors such as the interest rate and the market profit volatility we extend the exit model by allowing financially distressed firms to renegotiate their debt contracts through a one off debt exchange offer we find that firms with high bankruptcy costs or with prospects of profit improvement can get bigger reductions on their debt repayments investigating market entry we find that financial vulnerability of the incumbent induces earlier entry article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

predation reputation and entry deterrence abstract economists often argue that predatory practices are irrational since there exist cheaper or more certain means to gain or maintain a monopoly our gametheoretic equilibrium analysis suggests that if a firm is threatened by several potential entrants then predation may be rational against early entrants even if it is costly when viewed in isolation because it yields a reputation which deters other entrants asymmetric information plays a crucial role in our analysis since it provides the rationale for entrants to base their expectations of the firm s future behavior on its past actions the analysis also suggests methods to treat general reputational phenomena

the strategic impact of resource flexibility in business groups we show that in business groups with efficient internal capital markets resources may be channelled to either more or less profitable units depending on the amount of internal resources a group may exit a market in response to increased competition or channel funds to the subsidiary operating in that market this has important implications for the strategic impact of group membership affiliation to a monopolistic subsidiary can make a cash rich poor firm more less vulnerable to entry deterrence also resource flexibility within a group makes subsidiaries reaction functions flatter thus discouraging rivals strategic commitments when entry is accommodated

controlling monetary aggregates the discount window this paper argues that current discount window policy coupled with non borrowed reserve targeting of the federal reserve makes the quantity of high powered money endogenous examination of the advisability of this procedure in a stochastic environment is conducted using a general equilibrium financial model it is concluded that the current policy reduces the destabilizing effects of shifts between various depository financial assets but increases the effect of other asset portfolio shifts and aggregate supply disturbances these results are consistent with the work of poole inasmuch as the current debate over discount policy is a repackaging of the debate over interest rate or aggregates control for monetary policy

conflicting interests in information disclosure and short term orientation of firms abstract this paper explains why firms might be excessively short term oriented even when they are able to inform the capital market about the true quality of their assets the information a firm reveals to the capital market can be used by competitors to the firm s detriment in this case the future profitability of the firm s assets is no longer exogenous but is influenced by the strategic actions of its competitors which in turn depend on the information the firm discloses this motivates the firm to switch resources from future prospects to short term profits the results have policy implications and may help explain the empirical observation that u s firms tend to be more short term oriented than japanese firms

a comparison of stock market mechanisms i analyze a multi asset market under two trading mechanisms in the first the unrestricted system traders demand for each asset depends on all equilibrium prices and prices reflect the information contained in all order flows in the second the restricted system traders demand depends on the traded asset price and prices reflect single order flow information i show that informed traders use of multidimensional private information depends on the number of prices they observe and on the price formation process i then give conditions rendering the restricted system more efficient than the unrestricted system

predatory price wars duopoly profits justify production price war losses are sunk when a firm decides to exit even if a price war has drained a firm s financial reserves if the firm has access to a profitable duopoly opportunity it should be able to secure external financing only potential future profitability should matter both to capital markets and to a victim of predation fudenberg and tirole 1986 poitevin 1988 and bolton and sharfstein 1990 have addressed this question these papers show how capital market imperfections can affect product market competition and so create the potential for predation this paper examines a moral hazard problem similar to bolton and sharfstein the potential for a firm to earn a hidden profit a financial contract calls for funds to be transferred to a firm which that firm then channels into some productive technology in this paper outside of default only the firm observes its actions and earnings in a state of default investors are able to determine and claim earnings from production but the investor cannot observe the past conduct of the firm that is investors can only determine legitimate earnings from production but cannot observe returns from any other outside business activities because of this a firm can misallocate the resources away from production to earn some hidden return while producing a loss for the investors to claim since investors cannot observe the conduct of the firm financial contracts are necessarily incomplete and so recipients of funding are free to misallocate transferred resources for clarity the paper examines the case where all of the financial resources can be misallocated and so a firm can in effect take the money and run

how does industry affect firm financial structure we examine the importance of industry to firm level financial and real decisions we find that in addition to standard industry fixed effects financial structure also depends on a firm s position within its industry in competitive industries a firm s financial leverage depends on its natural hedge its proximity to the median industry capital labor ratio the actions of other firms in the industry and its status as entrant incumbent or exiting firm financial leverage is higher and less dispersed in concentrated industries where strategic debt interactions are also stronger but a firm s natural hedge is not significant our results show that financial structure technology and risk are jointly determined within industries these findings are consistent with recent industry equilibrium models of financial structure copyright 2005 oxford university press