David S. Scharfstein

Corporate Structure, Liquidity, and Investment: Evidence from Japanese Industrial Groups

This paper presents evidence suggesting that information and incentive problems in the capital market affect investment. We come to this conclusion by examining two sets of Japanese firms. The first set has close financial ties to large Japanese banks that serve as their primary source of external finance and are likely to be well informed about the firm. The second set of firms has weaker links to a main bank and presumably faces greater problems raising capital. Investment is more sensitive to liquidity for the second set of firms than for the first set. The analysis also highlights the role of financial intermediaries in the investment process.

The Role of Banks in Reducing the Costs of Financial Distress in Japan

This paper explores the idea that financial distress is costly because free-rider problems and information asymmetries make it difficult for firms to renegotiate with their creditors in times of distress. We present evidence consistent with this view by showing Japanese firms with financial structures in which free-rider and information problems are likely to be small perform better than other firms in industrial groups-those with close financial relationships to their banks, suppliers, and customers-invest more and sell more after the onset of distress than non-qroup firms. Moreover, firms that are not group members, but nevertheless have strong ties to a main bank also invest and sell more than firms without strong bank ties.

Optimal Debt Structure and the Number of Creditors

Within an optimal contracting framework, we analyze the optimal number of creditors a company borrows from. We also analyze the optimal allocation of security interests among creditors and intercreditor voting rules that govern renegotiation of debt contracts. The key to our analysis is the idea that these aspects of the debt structure affect the outcome of debt renegotiation following a default. Debt structures that lead to inefficient renegotiation are beneficial in that they deter default, but they are also costly if default is beyond a managers control. The optimal debt structure balances these effects. We characterize how the optimal debt structure depends on firm characteristics such as its technology, its credit rating, and the market for its assets.

Product-Market Competition and Managerial Slack

This article analyzes the effect of product-market competition on managerial incentives. In contrast to Hart (1983a), I show that competition may actually exacerbate the incentive problem. The difference in results derives from our different assumptions about managerial preferences. The importance of assumptions about preferences suggests that we do not yet understand the precise mechanism through which competition affects incentives.

The Disciplinary Role of Takeovers

This paper presents a theory of the disciplinary role of takeovers based on an explicit model of managerial incentive problems stemming from asymmetric information. It is argued that an informed raider can reduce incentive problems by making managerial compensation more sensitive to information unavailable to shareholders. The paper also highlights the importance of specifying the source of contractual inefficiencies when analyzing the effect of takeovers on incentives.

Simultaneous Signalling to the Capital and Product Markets

In this article we analyze an informed firms choice of financial structure when the financing contract is observed not only by the capital market but also by a second uninformed party, such as a competing firm. The informed firms gross profit is endogenous, because the second partys action depends on the transaction it observes between the informed firm and the capital market. The main result is that the reasonable capital-market equilibria maximize the ex ante expectation of the informed firms endogenous gross profits. In distinct contrast to earlier work, which focuses on separating equilibria, in our model it is often the case that all the reasonable equilibria are pooling.

Do Firm Boundaries Matter

ing from changes in capacity utilization. Ideally, we would like to look at both but lacking firm level data on utilization we can only examine one of the two dimensions for adjustment.

Testing in Models of Asymmetric Information

This paper explores the role of testing in models of asymmetric information. We demonstrate conditions under which testing for underlying characteristics can overcome adverse selection problems and lead to a full-information competitive equilibrium. This paper provides a more general statement of Mirrlees result on the optimal use of infinite fines. Where testing cannot fully resolve the problems associated with asymmetric information, we outline the source of the difficulties. Our results, developed in the context of a labour market, can be directly extended to other environments. In problems with asymmetric information, testing to discover an agents chosen action or underlying characteristics may significantly reduce the cost of moral hazard and adverse selection.